lOMoARcPSD|26196494 Ch06-1 - summary and sample questions Microeconomics 1 (The University of Western Ontario) Studocu is not sponsored or endorsed by any college or university Downloaded by hassaan ansari (hassaanskb@gmail.com) lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual Chapter 6 Inputs and Production Functions Solutions to Review Questions 1. We said that the production function tells us the maximum output that a firm can produce with its quantities of inputs. Why do we include the word maximum in this definition? The production function tells us the maximum volume of output that may be produced given a combination of inputs. It is possible that the firm might produce less than this amount of output due to inefficient management of resources. While it is possible to produce many levels of output with the same level of inputs, some of which are less technically efficient than others, the production function gives us the upper bound on (the maximum of) the level of output. 2. Suppose a total product function has the “traditional shape” shown in Figure 6.2. Sketch the shape of the corresponding labor requirements function (with quantity of output on the horizontal axis and quantity of labor on the vertical axis). The labor requirements function, which is the inverse of the production function, tells us the minimum amount of labor that is required to produce a given amount of output. 30 25 L 20 15 10 5 0 0 50 100 150 200 250 Q 3. What is the difference between average product and marginal product? Can you sketch a total product function such that the average and marginal product functions coincide with each other? Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 1 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual The average product of labor is the average amount of output per unit of labor. APL Total Product Q Quantity of Labor L The marginal product of labor is the rate at which total output changes as the firm changes its quantity of labor. MPL Change in Total Product Q Change in Quantity of Labor L The total product function in the graph below Q 3L , which is linear, would have the average and marginal products coincide. In particular, for all values of Q we would have APL MPL 3 . 250 Q 200 150 100 50 0 0 10 20 30 40 50 60 70 L 4. What is the difference between diminishing total returns to an input and diminishing marginal returns to an input? Can a total product function exhibit diminishing marginal returns but not diminishing total returns? With diminishing total returns to an input, increasing the level of the input will decrease the level of total output holding the other inputs fixed. Diminishing marginal returns to an input means that as the use of that input increases holding the quantities of the other inputs fixed, the marginal product of that input will become less and less. Essentially, diminishing total returns implies that output is decreasing while with diminishing marginal returns we could have output increasing, but at a decreasing rate as the amount of the input increases. It is entirely plausible to have a total product function exhibit diminishing marginal returns but not diminishing total returns. This would occur when each additional unit of an input increased the total level of output, but increased the level of output less than the Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 2 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual previous unit of the input did. Essentially, this occurs when output is increasing at a decreasing rate as the level of the input increases. 5. Why must an isoquant be downward sloping when both labor and capital have positive marginal products? If the marginal product of labor is positive, then when we increase the level of labor holding everything else constant this will increase total output. To keep the level of output at the original level, we need to stay on the same isoquant. To do so, since the marginal product of capital is positive we would then need to reduce the amount of capital being used. So, to keep output constant, when the level of one input increases the level of the other input must decrease. This negative relationship between the inputs implies the isoquant will have a negative slope, i.e., be downward sloping. 6. Could the isoquants corresponding to two different levels of output ever cross? No, as with indifference curves, isoquants can never cross. For example, suppose we draw isoquants for two levels of output Q1 and Q2 with Q2 Q1 . In addition, suppose that these isoquants crossed at some point A as in the following diagram. Capital C B A Q2 Q1 Labor Because A and B are on Q2, both achieve the same level of output. Since A and C are on Q1, both achieve the same level of output. This would imply that B and C achieve the same level of output. However, this is not possible since point C contains more of both inputs which would achieve a higher level of output. Therefore, isoquants cannot cross. 7. Why would a firm that seeks to minimize its expenditures on inputs not want to operate on the uneconomic portion of an isoquant? By operating on the uneconomic portion of an isoquant, the firm would be using a combination of inputs in which one of the inputs has a negative marginal product, i.e., increasing the input decreases the level of total output. At a point such as this, the firm could increase output by decreasing the level of the input. By decreasing the level of the input, the firm could decrease total cost. Thus, if a firm were operating on the uneconomic region of an isoquant it could simultaneously increase output and decrease Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 3 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual total cost. Thus, a cost-minimizing firm would never operate on this portion of an isoquant because it would always take advantage of this opportunity. 8. What is the elasticity of substitution? What does it tell us? The elasticity of substitution measures how the marginal rate of technical substitution of labor for capital changes as we move along an isoquant. Essentially this value tells us the level of substitutability between capital and labor, i.e., how easily the firm can substitute capital for labor to maintain the same level of total output. 9. Suppose the production of electricity requires just two inputs, capital and labor, and that the production function is Cobb–Douglas. Now consider the isoquants corresponding to three different levels of output: Q = 100,000 kilowatt-hours, Q = 200,000 kilowatt-hours, and Q = 400,000 kilowatt-hours. Sketch these isoquants under three different assumptions about returns to scale: constant returns to scale, increasing returns to scale, and decreasing returns to scale. Decreasing Returns to Scale Capital 1,000 750 Q=400,000 500 250 Q=200,000 Q=100,000 - 250 500 750 1,000 Labor With decreasing returns to scale the firm needs to more than double inputs to double output. Equivalently, doubling inputs less than doubles output. Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 4 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual Constant Returns to Scale Capital 1,000 750 500 Q=400,000 250 Q=200,000 Q=100,000 - 250 500 750 1,000 Labor With constant returns to scale the firms needs to double inputs to double output. Increasing Returns to Scale Q=100,000 Q=200,000 Q=400,000 Capital 1,000 750 500 250 - 250 500 750 1,000 Labor With increasing returns to scale the firm needs to less than double the inputs to double the output. Equivalently, doubling inputs more than doubles output. Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 5 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual Solutions to Problems 6.1 A firm uses the inputs of fertilizer, labor, and hothouses to produce roses. Suppose that when the quantity of labor and hothouses is fixed, the relationship between the quantity of fertilizer and the number of roses produced is given by the following table: a) What is the average product of fertilizer when 4 tons are used? b) What is the marginal product of the sixth ton of fertilizer? c) Does this total product function exhibit diminishing marginal returns? If so, over what quantities of fertilizer do they occur? d) Does this total product function exhibit diminishing total returns? If so, over what quantities of fertilizer do they occur? Q 2200 550 . F 4 a) APF b) MPF c) Diminishing marginal returns set in when MPF for some unit is lower than MPF for the previous unit. This occurs for F 3 . d) Diminishing total returns set in at the point where total output begins to fall. This occurs for F 6 . Q 2600 2500 100 . F 6 5 6.2. A firm is required to produce 100 units of output using quantities of labor and capital (L, K) = (7, 6). For each of the following production functions, state whether it is possible to produce the required output with the given input combination. If it is possible, state whether the input combination is technically efficient or inefficient. a) Q = 7L + 8K b) Q = 20√KL c) Q = min(16L, 20K) d) Q = 2(KL + L + 1) a) The input combination gives Q = 97 so it is infeasible. b) Q = 129.6 which is greater than 100, so feasible, but inefficient. c) Q = 112 so again feasible but inefficient. Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 6 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual d) Q = 100 therefore the required output is feasible and the input combination is efficient. 6.3. For the production function Q = 6L2 − L3, fill in the following table and state how much the firm should produce so that: a) average product is maximized b) marginal product is maximized c) total product is maximized d) average product is zero The completed table is shown below: L Q 0 0 1 5 2 16 3 27 4 32 5 25 6 0 a) You can calculate the average product at each point by just dividing total output by L. The values obtained are 0,5,8,9,8,5,0. Therefore Average Product is maximized when L = 3. b) The marginal product at values 1 through 6 are respectively: 5,11,11,5,–7, –25. Therefore both the second and the third unit of L give the greatest marginal increase in output [if you use calculus techniques it can be seen that marginal product is maximized when L = 2]. c) From the Table it is clear that total product is maximized when L = 4. d) Average Product will be zero only when Total Product is zero. This happens when L = 6. Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 7 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual 6.4. Suppose that the production function for DVDs is given by Q = KL2 − L3, where Q is the number of disks produced per year, K is machine-hours of capital, and L is man-hours of labor. a) Suppose K = 600. Find the total product function and graph it over the range L = 0 to L = 500. Then sketch the graphs of the average and marginal product functions. At what level of labor L does the average product curve appear to reach its maximum? At what level does the marginal product curve appear to reach its maximum? b) Replicate the analysis in (a) for the case in which K = 1200. c) When either K = 600 or K = 1200, does the total product function have a region of increasing marginal returns? a) Total Product Total Product with K=600 40,000,000 30,000,000 20,000,000 10,000,000 0 100 200 300 400 500 600 700 Labor AP and MP with K=600 200000 AP/MP AP 0 0 100 200 300 400 500 600 700 -200000 -400000 MP Labor Based on the figure above it appears that the average product reaches its maximum at L = 300. The marginal product curve appears to reach its maximum at L = 200. Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 8 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual b) Total Product Total Product with K=1200 300,000,000 200,000,000 100,000,000 0 500 1000 1500 Labor AP/MP AP and MP with K=1200 1000000 500000 0 -500000 0 -1000000 -1500000 -2000000 AP 200 400 600 800 1000 1200 1400 MP Labor Based on the figure above it appears that the average product curve reaches its maximum at L = 600. The marginal product curve appears to reach its maximum at L = 400. c) In both instances, for low values of L the total product curve increases at an increasing rate. For K = 600, this happens for L < 200. For K = 1200, it happens for L < 400. 6.5. Are the following statements correct or incorrect? a) If average product is increasing, marginal product must be less than average product. b) If marginal product is negative, average product must be negative. c) If average product is positive, total product must be rising. d) If total product is increasing, marginal product must also be increasing. Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 9 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual a) Incorrect. When MP AP we know that AP is increasing. When MP AP we know that AP is decreasing. b) Incorrect. If MP is negative, MP < 0. But AP = Q / L can never be negative since total product Q and the level of input L can never be negative. Thus, MP < 0 < AP, which only implies that AP is falling. c) Incorrect. Average product is always positive, so this tells us nothing about the change in total product. Whether or not total product is rising depends on whether or not marginal product is positive. d) Incorrect. If total product is increasing we know that MP 0 . If diminishing marginal returns have set in, however, marginal product will be positive but decreasing, but that does not preclude MP > 0. 6.6. Economists sometimes “prove” the law of diminishing marginal returns with the following exercise: Suppose that production of steel requires two inputs, labor and capital, and suppose that the production function is characterized by constant returns to scale. Then, if there were increasing marginal returns to labor, you or I could produce all the steel in the world in a backyard blast furnace. Using numerical arguments based on the production function shown in the following table, show that this (logically absurd) conclusion is correct. The fact that it is correct shows that marginal returns to labor cannot be everywhere increasing when the production function exhibits constant returns to scale. To develop the answer, suppose that we were initially producing 64 units of steel. According to the table, we could do this with 8 units of labor and 100 units of capital. Now, since we have constant returns to scale, if we double the amount of labor and capital, i.e., L = 16 and K = 200, we can double output, i.e., produce Q = 128 units of steel. But notice from the table that the input combination L = 16 and K = 100 results in an even greater output of Q = 256 units of steel. Thus, by reducing the amount of capital it uses (from K = 200 to K = 100), holding the quantity of labor fixed, the firm can produce more output! That is, the marginal product of capital is negative over this range. We can see the same thing if we start with any other input combination. For example, suppose the firm is initially producing 4 units of steel using 2 units of labor and 100 units Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 10 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual of capital. Because of constant returns to scale, if we double the amount of labor and capital, i.e., L = 4 and K = 200, we can double output, i.e., produce Q = 8 units of steel. But notice from the table that the input combination L = 4 and K = 100 results in an even greater output of Q = 16 units of steel. Again, by reducing the amount of capital it uses (holding the quantity of labor fixed), the firm can produce more output. Again, we see that the marginal product of capital is negative. The above calculations illustrate that a two-input production function with (a) constant returns to scale and (b) increasing marginal returns to labor must necessarily imply that the marginal product of capital is negative. And, of course, if the marginal product of capital is negative, the firm can expand output by reducing the amount of capital it uses. It could, theoretically, produce an enormous amount of steel in a backyard blast furnace. Because this conclusion is absurd, the point of the illustration is that with constant returns to scale, marginal returns to labor cannot be everywhere increasing. Eventually the law of diminishing marginal returns must set in. 6.7. The following table shows selected input quantities, total products, average products, and marginal products. Fill in as much of the table as you can: Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 11 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual The correct answers are shown in bold face red type. Labor, L 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Total product, Q 0 19 72 153 256 375 504 637 768 891 1000 1089 1152 1183 1176 1125 APL 0 19 36 51 64 75 84 91 96 99 100 98 96 91 84 75 MPL ---19 53 81 103 119 129 133 131 123 109 89 63 31 -7 -51 6.8. Widgets are produced using two inputs, labor, L, and capital, K. The following table provides information on how many widgets can be produced from those inputs: a) Use data from the table to plot sets of input pairs that produce the same number of widgets. Then, carefully, sketch several of the isoquants associated with this production function. b) Find marginal products of K and L for each pair of inputs in the table. c) Does the production function in the table exhibit decreasing, constant, or increasing returns to scale? a) Three sample isoquants: red for production of 4 widgets (Q = 4), green for production of 8 widgets (Q = 8), and blue for production of 12 widgets (Q = 12). The dots represent particular combinations of inputs. Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 12 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual K 4 3 (4,2) 2 (1,1) 1 Q=8 Q=8 Q=4 0 1 2 3 4 L b) Recall that marginal product of an input, say labor, is given by Q/L. If we compute the marginal product of labor and capital at any point in the table, we find that it always equals 2. For example, in moving from input combination (2,2) to (3,2), we increase output from 8 to 10. Hence, MPL = (10 – 8)/(3 – 2) = 2. c) From the table, we see that as we increase the quantity of each input by a given proportion, the quantity produced increases by the same proportion. Hence, in moving from input combination (1,1) to (3,3), we are tripling the quantity of labor and capital used. As a result, the quantity of output produced triples as well. where Q is the quantity of 6.9 Suppose the production function for automobiles is automobiles produced per year, L is the quantity of labor (man-hours) and K is the quantity of capital (machine-hours). a. Sketch the isoquant corresponding to a quantity of Q = 100? b. What is the general equation for the isoquant corresponding to any level of output Q? c. Does the isoquant exhibit diminishing marginal rate of technical substitution? a. The Q = 100 isoquant looks like this: Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 13 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual b. We find the general equation of an isoquant for this production function by starting with the production function and solving for K in terms of L. Thus, since Q = LK, the general equation of an isoquant for this production function is The isoquants for this production function exhibit diminishing marginal rate of technical substitution. We can see this from the graph above which shows that the isoquant is convex to the origin. Capital 6.10. Suppose the production function is given by the equation Q = L√K. Graph the isoquants corresponding to Q = 10, Q = 20, and Q = 50. Do these isoquants exhibit diminishing marginal rate of technical substitution? 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 Q=50 Q=10 Q=20 0 20 40 60 80 Labor Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 14 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual Because these isoquants are convex to the origin they do exhibit diminishing marginal rate of technical substitution. 6.11. Consider again the production function for DVDs: Q = KL2 − L3. a) Sketch a graph of the isoquants for this production function. b) Does this production function have an uneconomic region? Why or why not? a) 50.0 Q=150 Capital 40.0 30.0 Q=100 20.0 Q=50 10.0 0.0 0 10 20 30 40 Labor b) Because each of these isoquants has an upward-sloping portion beyond some level of labor, each one does indeed have an uneconomic region. 6.12. Suppose the production function is given by the following equation (where a and b are positive constants): Q = aL + bK. What is the marginal rate of technical substitution of labor for capital (MRTSL,K) at any point along an isoquant? For this production function MPL a and MPK b . The MRTS L , K is therefore MRTS L , K MPL a MPK b 6.13. You might think that when a production function has a diminishing marginal rate of technical substitution of labor for capital, it cannot have increasing marginal products of capital and labor. Show that this is not true, using the production function Q = K2L2, with the corresponding marginal products MPK = 2KL2 and MPL = 2K2L. First, note that MRTSL,K = L/K, which diminishes as L increases and K falls as we move along an isoquant. So MRTSL,K is diminishing. However, the marginal product of capital MPK is increasing (not diminishing) as K increases (remember, the amount of labor is Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 15 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual held fixed when we measure MPK.) Similarly, the marginal product of labor is increasing as L grows (again, because the amount of capital is held fixed when we measure MPL). This exercise demonstrates that it is possible to have a diminishing marginal rate of technical substitution even though both of the marginal products are increasing. 6.14 Consider the following production functions and their associated marginal products. For each production function, determine the marginal rate of technical substitution of labor for capital, and indicate whether the isoquants for the production function exhibit diminishing marginal rate of substitution. Production function MPL MPK MRTSL,K Diminishing marginal product of labor? Diminishing marginal product of capital? Diminishing marginal rate of technical substitution NO YES NO YES NO YES YES YES YES NO NO YES NO NO NO 6.15. Suppose that a firm’s production function is given by Q = KL + K, with MPK = L + 1 and MPL = K . At point A, the firm uses K = 3 units of capital and L = 5 units of labor. At point B, along the same isoquant, the firm would only use 1 unit of capital. a) Calculate how much labor is required at point B. b) Calculate the elasticity of substitution between A and B. Does this production function exhibit a higher or lower elasticity of substitution than a Cobb–Douglas function over this range of inputs? a) At point A, the firm produces 18 units of output. Therefore, since B is on the same isoquant, it must be that L = 17 at B. b) The capital-to-labor ratio at A is 3/5 and MRTSL,K = ½. At B, the capital-to-labor ratio is 1/17, and MRTSL,K = 1/18. Therefore the elasticity of substitution is (1 / 17 3 / 5) /(3 / 5) 69 . (1 / 18 1 / 2) /(1 / 2) 68 Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 16 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual A Cobb-Douglas production function has an elasticity of substitution of 1. Therefore this production function has a slightly higher elasticity of substitution, indicating a slightly greater ease of substitutability of inputs. 6.16. Two points, A and B, are on an isoquant drawn with labor on the horizontal axis and capital on the vertical axis. The capital–labor ratio at B is twice that at A, and the elasticity of substitution as we move from A to B is 2. What is the ratio of the MRTSL,K at A versus that at B? Since the capital-labor ratio at B is twice that at A, it implies that the percent change in this ratio as we move from A to B is 100%. If we denote the percent change in the MRTS over these two points as x then using the definition of elasticity of substitution, 100 2, which means that %MRTS L , K 50. %MRTS L , K Equivalently, MRTS B MRTS A MRTS A 2 100 50. Solving, . MRTS A MRTS B 3 6.17. Let B be the number of bicycles produced from F bicycle frames and T tires. Every bicycle needs exactly two tires and one frame. a) Draw the isoquants for bicycle production. b) Write a mathematical expression for the production function for bicycles. a) This isoquants for this situation will be L-shaped as in the following diagram Tires 6 Q=3 4 Q=2 2 Q=1 1 2 3 Frames These L-shaped isoquants imply that once you have the correct combination of inputs, say 2 frames and 4 tires, additional units of one resource without more units of the other resource will not result in any additional output. b) Mathematically this production function can be written Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 17 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual 1 Q min( F , T ) 2 where F and T represent the number of frames and tires. 6.18. To produce cake, you need eggs E and premixed ingredients I. Every cake needs exactly one egg and one package of ingredients. When you add two eggs to one package of ingredients, you produce only one cake. Similarly, when you have only one egg, you can’t produce two cakes even though you have two packages of ingredients. a) Draw several isoquants of the cake production function. b)Write a mathematical expression for this production function. What can you say about returns to scale of this function? a) mix 1 b) 2 3 eggs The formula is # of cakes = Min{# of eggs, # of ingredients’ packages}. This production function has constant returns to scale. To see why, let x and y denoted the quantities of eggs and mix, respectively, and let Q denote the number of cakes produced. The equation of our production function is: Q = Min(x,y). If we increase each input by a factor of a, we have the following quantity of cake: min{ax, ay} = a min{x, y} = aQ. Hence, increasing the quantities of inputs by a given proportion results in the same proportionate increase in output, and the production function thus exhibits constant returns to scale. Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 18 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual 6.19. What can you say about the returns to scale of the linear production function Q = aK + bL, where a and b are positive constants? If we were to scale up all inputs by a factor (that is, replace K by K, and L by L), the resulting output would equal Q. Therefore a linear production function has constant returns to scale. 6.20. What can you say about the returns to scale of the Leontief production function Q = min(aK, bL), where a and b are positive constants? A general fixed proportions production function is of the form Q min(aK , bL) . If we were to scale up all inputs by a factor (that is, replace K by K, and L by L), the resulting output would be min(aK , bL) min(aK , bL) = Q. Therefore the production function has constant returns to scale. 6.21. A firm produces a quantity Q of breakfast cereal using labor L and material M with the production function Q = 50√ML + M+ L. The marginal product functions for this production function are a) Are the returns to scale increasing, constant, or decreasing for this production function? b) Is the marginal product of labor ever diminishing for this production function? If so, when? Is it ever negative, and if so, when? a) To determine the nature of returns to scale, increase all inputs by some factor and determine if output goes up by a factor more than, less than, or the same as . Q 50 M L M L Q 50 ML M L Q 50 ML M L Q Q By increasing the inputs by a factor of output goes up by a factor of . Since output goes up by the same factor as the inputs, this production function exhibits constant returns to scale. b) The marginal product of labor is Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 19 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual M 1 L Suppose M 0 . Holding M fixed, increasing L will have the effect of decreasing MPL . The marginal product of labor is decreasing for all levels of L . The MPL , however, will never be negative since both components of the equation above will always be greater than or equal to zero. In fact, for this production function, MPL 1 . MPL 25 6.22 Consider a production function whose equation is given by the formula which has corresponding marginal products, and Show that the elasticity of substitution for this production function is exactly equal to 1, no matter what the values of K and L are. ANSWER First note that In this case that implies, which simplifies to Now recall that the definition of the elasticity of substitution is Since it follows that will be exactly equal to (You can verify this by plugging in particular values for , an increase of 66.66 percent. Since . Suppose, for example, , and then changes to it follows that MRTSL,K changes from 1 to 1.5, (also an increase of 66.66 percent.) In other words, since the marginal rate of substitution of labor for capital is proportional to the capital-labor ratio, the percentage change in the marginal rate of substitution of labor for capital must equal the percentage change in the capital-labor ratio. Since then using the definition of the elasticity of substitution, it Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 20 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual follows that, 6.23. A firm’s production function is Q = 5L2/3K1/3 with MPK = (5/3)L2/3K−2/3 and MPL = (10/3)L−1/3K1/3. a) Does this production function exhibit constant, increasing, or decreasing returns to scale? b) What is the marginal rate of technical substitution of L for K for this production function? c) What is the elasticity of substitution for this production function? a) Notice that (aK)1/3(aL)2/3 = a1/3a2/3 K1/3 L2/3 = a K1/3 L2/3 = aQ. This production function exhibits constant returns to scale. b) MRTSL,K = MPL / MPK = 2 K/L . c) Because this is a Cobb-Douglas production function, its elasticity of substitution equals 1. 6.24. Consider a CES production function given by Q = (K0.5 + L0.5)2. a) What is the elasticity of substitution for this production function? b) Does this production function exhibit increasing, decreasing, or constant returns to scale? c) Suppose that the production function took the form Q = (100 + K0.5 + L0.5)2. Does this production function exhibit increasing, decreasing, or constant returns to scale? a) For a CES production function of the form 1 1 1 Q aL bK the elasticity of substitution is . In this example we have a CES production function of the form 2 Q K 0.5 L0.5 . To determine the elasticity of substitution, either set ( 1) / 0.5 or /( 1) 2 and solve for . Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 21 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual 1 0.5 1 0.5 0.5 1 2. In either case, the elasticity of substitution is 2. Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 22 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual b) Q ( K ) 0.5 ( L)0.5 2 Q ( 0.5 )( K 0.5 L0.5 ) 2 2 Q K 0.5 L0.5 Q Q. Since output goes up by the same factor as the inputs, this production function exhibits constant returns to scale. c) Q 100 ( K )0.5 ( L)0.5 Q 100 0.5 ( K 0.5 L0.5 ) 2 2 2 100 Q 0.5 K 0.5 L0.5 Q. When the inputs are increased by a factor of , where 1 output goes up by a factor less than implying decreasing returns to scale. Intuitively, in this production function, while you can increase the K and L inputs, you cannot increase the constant portion. So output cannot go up by as much as the inputs. 6.25 Consider the following production functions and their associated marginal products. For each production function, indicate whether (a) the marginal product of each input is diminishing, constant, or increasing in the quantity of that input; (b) the production function exhibits decreasing, constant, or increasing returns to scale. Production function MPL MPK Marginal product of labor? CONSTANT in L DIMINISHING in L Marginal product of capital? CONSTANT in K DIMINISHING in K Returns to scale? CONSTANT CONSTANT DIMINISHING DIMINISHING DECREASING in L in K INCREASING in L CONSTANT in L INCREASING in K CONSTANT in K Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) INCREASING INCREASING Chapter 6 - 23 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual 6.26. The following table presents information on how many cookies can be produced from eggs and a mixture of other ingredients (measured in ounces): Recently, you found a new way to mix ingredients with eggs. The same amount of ingredients and eggs produces different numbers of cookies, as shown in the following table: a) Verify that the change to the new production function represents technological progress. b) For each production fuction find the marginal products of eggs when mixed ingredients is held fixed at 8. Verify that when mixed ingredients is held fixed at 8, the technological progress increases the marginal product of eggs. a) For each pair of inputs, except those where there are no eggs or no other ingredients, new recipe produces more cookies. Hence, the new recipe represents technological progress. b) MPE =Q/E, where E denotes the quantity of eggs. With mixed ingredients held fixed at 8, we have: MPE = (8 – 0)/(1 – 0) = 8, when E goes from 0 to 1. MPE = (16 – 8)/(2 – 1) = 8, when E goes from 1 to 2. MPE = (16 – 16)/(3 – 2) = 0, when E goes from 2 to 3. MPE is zero for all subsequent changes in E. After the technological progress we have: MPE = (10 – 0)/(1 – 0) = 10, when E goes from 0 to 1. MPE = (19 – 10)/(2 – 1) = 9, when E goes from 1 to 2. MPE = (22 – 19)/(3 – 2) = 3, when E goes from 2 to 3. MPE = (23 – 22)/(4 – 3) = 1, when E goes from 3 to 4. Comparing the marginal products, we see that MPE (when mix equals 8 is higher after the technological progress. Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 24 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual 6.27. Suppose a firm’s production function initially took the form Q = 500(L + 3K). However, as a result of a manufacturing innovation, its production function is now Q = 1000(0.5L + 10K). a) Show that the innovation has resulted in technological progress in the sense defined in the text. b) Is the technological progress neutral, labor saving, or capital saving? a) It is possible to write the two production functions as Q1 500 L 1,500 K Q2 500 L 10, 000 K Since Q2 Q1 for given quantities of K and L , the firm can achieve more output for a given combination of inputs. This innovation has therefore resulted in technological progress as defined in the text. b) Initially MPK 1,500 and MPL 500 implying the MRTS L , K 0.33 . After the innovation the MPK 10, 000 and MPL 500 implying the MRTS L , K 0.05 . Since the marginal rate of technical substitution of labor for capital has decreased after the innovation this is labor-saving technological progress. 6.28. A firm’s production function is initially Q = KL, with MPK = 0.5(√L/√K) and MPL = 0.5(√K/√L). Over time, the production function changes to Q = KL, with MPK = L and MPL = K. a) Verify that this change represents technological progress. b) Is this change labor saving, capital saving, or neutral? a) With any positive amounts of K and L, KL KL so more Q can be produced with the final production function. So there is indeed technological progress. b) With the initial production function MRTS L , K MPL K . MPK L With the final production function MRTS L , K MPL K . MPK L For any ratio of capital to labor, MRTSL,K is the same for the two production functions. Thus, the technological progress is neutral. 6.29. A firm’s production function is initially Q = KL, with MPK = 0.5(√L/√K) and MPL = 0.5(√K/√L). Over time, the production function changes to Q = K√L, with MPK = √L and MPL = 0.5(K/√L). Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 25 lOMoARcPSD|26196494 Besanko & Braeutigam – Microeconomics, 5th editionSolutions Manual a) Verify that this change represents technological progress. b) Is this change labor saving, capital saving, or neutral? a) With any positive amounts of K and L, KL K L so more Q can be produced with the final production function. So there is indeed technological progress. b) With the initial production function MRTS L , K MPL K . MPK L With the final production function MRTS L , K MPL 0.5K . MPK L For any ratio of capital to labor, MRTSL,K is lower with the second production function. Thus, the technological progress is labor-saving. 6.30 Suppose that in the 21st century the production of semiconductors requires two inputs: capital (denoted by K) and labor (denoted by L). The production function takes the form However, in the 23rd century, suppose the production function for semiconductors will take the form In other words, in the 23rd century it will be possible to produce semiconductors entirely with capital (perhaps because of robots). a. Does this change in the production function change the returns to scale? b. Is this change in the production function an illustration of technological progress? a. No. In both the 21st and 23rd centuries, the production function for this good exhibited constant returns to scale. In both cases, increasing inputs by a given proportion increases output by the same proportion. b. The change in the production function is not an example of technological progress. This is because we do not get more output from a given combination of inputs. For example, if L = 100, K=100, in the 21st century . In the 21st century, with the same input combination, we would get the same output, Q = 100. Copyright © 2014 John Wiley & Sons, Inc. Downloaded by hassaan ansari (hassaanskb@gmail.com) Chapter 6 - 26