Problem Set #5: Technology, Profit Maximization, Cost Minimization
Microeconomics I
To be solved for Seminar 5 on May 30/31, 2024.
The problems marked with an asterisk (∗ ) will be given higher priority in the seminars.
Technology and Returns to Scale.
1. If f (x) = xα is a production function. Prove that:
(a) If 0 < α < 1 this production function has decreasing returns to scale.
(b) If α > 1 this production function has increasing returns to scale.
(c) Is there any value for α such that the production function exhibits constant
returns to scale?
2. (∗ ) For each of the following production functions determine the marginal product
of the inputs (M PL , M PK ) as well as the type of returns to scale. Explain your
answer.
(a) f (L) = 4L
(b) f (L, K) = L + 6K
(c) f (L, K) = (L + 6K)2
(d) f (L, K) = 10LK
(e) f (L, K) = L2 K
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(f) f (L, K) = L 3 K 3
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(g) f (L, K) = L 2 K 2
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(h) f (L, K) = L 3 K 3
(i) f (L, K) = min{L, 4K}
q
(j) f (L, K) = min{L, 4K}
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Profit Maximization and Cost Minimization.
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3. (∗ ) A firm has the following production function f (L, K) = 5L 5 K 5 .
(a) Compute the marginal product of labor (M PL ) and the marginal product of
capital (M PK ) as well as the technical rate of substitution (T RS) for this
production function.
(b) In the short-run the firm cannot vary the input K and operates at K = 3.
Find and draw the short-run production function.
(c) Find the factor demand function for labor in the short-run if K = 3.
(d) Compute the optimal factor demand for labor in the short-run if K = 3 and
if the price of output is p = 3 and the price of the labor input is wL = 1.
(e) What is the TRS at the short-run solution computed in (d)?
(f) If the price of K is wK = 6, is the short-run solution computed in (d) optimal
in the long-run? Explain your answer.
(g) Determine the long-run factor demand functions that maximize the profit of
the firm.
(h) Determine the optimal factor demands and the quantity of output that maxi-
mizes the profit of the firm when the price of output is p = 3 and the price of
inputs are wL = 1, wK = 6.
(i) What is the TRS at the solution you obtained in (h). Does it differ from the
one obtained in (d)? Interpret your answer.
(j) What are the profits in (d) and (h)? Interpret.
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4. Consider a firm with the following production function f (x1 , x2 ) = (x1 ) 4 (x2 ) 2 .
Factor prices are w1 , w2 > 0.
(a) Draw some isoquants.
(b) What type of returns to scale does this production function exhibit?
(c) Specify the profit maximization problem for this firm.
(d) What is the marginal product of x1 and of x2 ?
(e) What is the technical rate of substitution?
(f) Determine the demand functions for the two factors.
(g) Specify the cost minimization problem for the firm given that it wants to
produce a level of output y.
(h) Determine the conditional demand functions for the two factors (conditional
on level of production y).
(i) Derive the total cost function, the average cost and the marginal cost functions.
5. (∗ ) A small competitive company produces Y pancakes per hour using L cooks and
K stoves according to the production function Y = 60LK/(L + K). The market
price of a pancake is p = 0, 60e and the market prices of the factors are w = 16
(e/cook-hour) and r = 4 (e/stove-hour).
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(a) Does this company have increasing, constant, or decreasing returns to scale?
Why? Give your answer, and without making any further computation, can
you say what will be the profits of this company? Will it depend on the exact
level of production? Explain your answer. (Hint: Think what the returns to
scale imply for the profits of the company, taking into account what they imply
for the costs and revenues: for a competitive company, doubling the inputs
means doubling the cost, while the revenues doubles / more than doubles /
less than doubles, depending on whether production has constant / increasing
/ decreasing returns to scale.)
(b) State the system of two equations with two unknowns (L and K) that charac-
terizes the solution of the problem of profit maximization of the company in
the long run. Show that the system does not have a well-defined solution in
this case. Why does this happen?
(c) Suppose now that in the short run the number of stoves is fixed at K = 16.
What is the level of production per hour that maximizes the firm’s profits in
this case? How many cooks will the company employ?
6. Consider the following cost function c(y) = y 2 + 2y + 1.
(a) Determine the variable cost function, the fixed costs, the average variable costs,
the average fixed costs, the average costs and the marginal costs. Draw the
corresponding curves.
(b) Determine the supply function of the firm if the market for its product, as well
as the markets for the factors are all perfectly competitive.
(c) If the product price if p = 8, determine the quantity supplied, the profit of the
firm as well as the producer’s surplus.