Problem Set 4
Production
1. For each production function given below, indicate whether (i) the marginal product of each
input is diminishing, constant, or increasing in the quantity of that input; (ii) the production
function exhibits decreasing, constant, or increasing returns to scale.
a) 𝑞 = √𝐿𝐾
b) 𝑞 = (𝐿𝐾)3
c) 𝑞 = 𝐿𝐾
d) 𝑞 = 𝐿 + 𝐾
e) 𝑞 = √𝐿 + √𝐾
2. Let 𝐵 be the number of bicycles produced from 𝐹 bicycle frames and 𝑇 tires. Every bicycle
needs exactly two tires and one frame. Write a mathematical expression for the production
function for bicycles.
3. Suppose that a firm’s production function is given by 𝑄 = 𝐾𝐿 + 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. Calculate how much labor is required at point 𝐵.
Costs and Input Choice
1. A firm has a fixed cost of 100. Its short-run production function is 𝑞 = 5√𝑀, where 𝑞 is the
output and 𝑀 is the variable input to be used. The price of the variable factor is 20 per unit.
Find the short-run total cost function for the firm.
2. Suppose a firm’s production function is given by 𝑞 = 𝐿𝐾. If the wage rate for labor is 𝑤 and
the rental rate of capital is 𝑟, then find the equation for the firm’s demand for labor.
3. Winry wants to open a flower shop in a mall. The monthly rental will be Rs. 1 a square foot.
She estimates that if she has 𝐹 square feet of floor space and sells 𝑦 bouquets a month, her
variable cost will be 𝑉𝐶 = 𝑦 2 /𝐹 per month. If she has 200 square feet of floor space, write
down her marginal cost and average cost functions. At what level of output is the average cost
minimized? At this level of output, how much is the average cost?
4. A consulting firm has just finished a study for a manufacturer of wine. It has determined that
an additional person-hour of labor would increase wine output by 1,000 gallons per day.
Adding another machine-hour of fermentation capacity would increase output by 200 gallons
per day. The price of a person-hour of labor is $10 per hour. The price of a machine-hour of
fermentation capacity is $0.25 per hour. Is there a way for the wine manufacturer to lower its
total costs of production and yet keep its output constant? If so, what is it?
5. Suppose the production of airframes is characterized by the production function: 𝑄 = 𝐿𝐾.
Suppose the price of labor is $10 per unit and the price of capital is $1 per unit. Find the cost-
minimizing combination of labor and capital if the manufacturer wants to produce 121,000
airframes.
Perfectly Competitive Markets
1. The short-run total cost of production of a firm operating in a perfectly competitive market is
𝑆𝑇𝐶(𝑄) = 40 + 10𝑄 + 0.1𝑄 2. The prevailing market price is $20.
a) What quantity this firm should produce to maximize profit?
b) What is this firm’s maximum profit?
c) What is the firm’s short-run supply curve, assuming that all of the $40 fixed costs are
sunk?
2. Multiple Choice Question:
Suppose that, at the current level of output, a firm in a perfectly competitive market is
producing at a level such that price exceeds marginal cost, P > MC. Marginal cost is normally
shaped (U-shaped). The firm
A) is currently maximizing profit since it is charging a price higher than marginal cost.
B) could increase profit by lowering the level of output.
C) could increase profit by increasing the level of output.
D) cannot increase profit without raising price.