Chapter 6 (production theory and analysis)

Problems

Use the production function Q =10K0.5 L0.6 to complete the following production table.

1)a) for this production system are returns to scale decreasing, constant or increasing?
Explain

The table is completed below :

Rate of capital input (K)

6 24.5 37.13 47.35 56.3 64.33 71.8

5 22.36 33.89 43.23 51.37 58.73 65.52
4 20 30.3 38.66 45.94 52.53 58.60
3 17.32 26.25 33.48 39.79 45.5 50.75
2 14.14 21.44 27.3 32.49 37.14 41.44
1 10.0 15.16 19.33 22.97 26.27 29.3
1 2 3 4 5 6
Rate of labor input(L)

Here maximum production with 1 unit of capital(K) and 3 units of labor is 19.33.Doubling the
input rates to K=2 and L=6 results in the rate of output doubling to Q = 41.44 .

It is characterized by increasing returns to scale because α+β =0.5+0.6 =1.1 . As it is greater than
1 it is a constant returns to scale.
if both input rates are increased by same factors and output rate increases by more than that
proportion then it is known as increasing returns to scale. Eg. if both input rates are doubled and
output increased by three times then we will say that increasing returns to scale

b) suppose the wage rate is tk 28, the price of capital also is tk 28 per unit, and the firm is
currently producing 30.3 units of output per period using four units of capital and two
units of labor. Is this an efficient resource combination? explain /what would be a more
efficient (not necessarily the best) combination? why

Q=10K0.5 L0.6 W=28 tk Q =30.3 units K=4 units L =2units

6-5)For each of the following production functions determine whether returns to scale are
decreasing, constant or increasing

The returns to scale refer how much output changes given a proportional change in all inputs
where all the inputs change by the same factor. For example,

F(zK , zL) = AKaLb <zF(K , L) decreasing returns to scale

= zF(K,L) constant returns to scale

> zF (K ,L) increasing returns to scale

a)Q=2K+3L+KL

let Q0 = F(K ,L) =2K +3L+KL be the initial production function.

Q1 =F(zK ,zL) =2(zK)+3(zL)+(zK)(zL) {multiply the function by z}

Here F(zK ,zL) > zF(K ,L)

z(2K+3L+zKL) > z(2K+3L+KL)

2K+3L+zKL > 2k+3L+KL

zKL > KL

z >1

it represents the increasing returns to scale.

b)Q=20K0.6 L0.5

let Q0 =F(K,L) =20K0.6L0.5

Q1 = F(zK,zL) =20(zK)0.6 (zL)0.5 = z0.6 z0.5 20K0.6 L0.5 = z1.1 Q0

Here F(zK ,zL) > zF(K, L)

It represents increasing returns of scale.

c)Q =100+3K+2L

Let Q0=F(K,L)=100+3K+2L be the initial production function, then after multiplying it by

factor z we obtain:

Q1=F(zK,zL)=100+3(zK)+2(zL)

Here F(zK ,zL) <zF(K,L)

100+3(zK)+2(zL) < 100z+3(zK)+2(zL) {decreasing returns to scale}

d) Q =5K aLb where a+b= 1

Q0 =F(K ,L) =5K aLb

Q1 =F(zK ,zL) =5(zK) a (zL) b = za z b 5K a Lb = za+b Q0 =zQ0

Here F(zK ,zL) =zF(K , L)

It represents constant returns to scale

e)Q=10K aLb where a+b=1.2

Q0=F(K,L)=10KaLb , where a+b=1.2

Q1= F(zK ,zL) =10 (zK)a (zL)b = za zb 10Ka Lb = za+b 10Ka Lb = Z1.2 Q0

Here F(zK ,zL) >zF(K ,L)

It represents increasing returns to scale.

f) Q=K/L

Q0=F(K,L)=K/L =KL-1
Q1=F(zk ,zL) =(2K)(2L)-1 =2.2-1 KL-1 =KL-1

In this case F(2K,2L) =2F(K ,L)

It represents the constant returns to scale.

6-2 Use the data from 6-1 to answer the following

a.If the rate of capital input is fixed at three and if output sells for $5 per unit, determine
the total, average, and marginal product functions and the marginal revenue product
function for labor in the following table.

L TPL APL MPL MRPL

0
1
2
3
4
5
6

We know , APL =TPL/L

MPL =∆Q/∆L

6-4. The marginal product of labor function for International Trading Inc. is given by the
equation

√k
MPL = 10
√L

"currently, the firm is using l00 units of capital and 121 units of Given the very specialized
nature 0f the capital equipment it takes six to nine months to increase the capital stock,
but the rate of. Labor input can be varied daily. If the price of labor is 10$ per unit and the
price of output is 2$ per unit, Is.the firm operating efficiently in the short run? if not,
explain why, and determine the optimal rate of labor input.

here , K =100 units L =121 units

P =10$ price of output Q =$2 per unit

MPL = 10×
√ 100 =9.09
√ 121
√ 121
MPk = 10 × √ 100 =11

Since the firm is operating efficiently

MPK/MPL =w/r

If w =$10 then 11/9.09 =K/10

K =12.10

The firm is operating in the short run.

6-8 )For the production function Q = 20K0.5L0.5 determine four combinations of capital and labor
that will produce 100 and 200 units of output. Plot these points on a graph and use them to sketch
the 100- and 200-unit isoquants.

When Q =100 units

1) Q =20 x√25 x√1 =100 K =25 L =1

2) K=6.25 L=4
3) K= 4 L =6.25
4) K=1 L=25

When Q = 200 units

1) K=100 L=1
2) K=25 L=4
3) K=4 L=25
4) K=1 L=100

6.7.The production function of goa sailboats ltd is

Q =20 √K√L

With marginal product funtions

 √L √K
MPk = 10 and MPL =10
√k √L

a) If the price of capital $5 per unit and the price of labor is $4 per unit determine the
expansion path for the firm.

Expansion path is determined by

MPL/MPK =w/r

10 L−0.5 K 0.5 4
¿, =
10 L0.5 K−0.5 5
K/L =4/5
4L =5K
L =1.25K
b) The firm currently is producing 200 units of output per period using input rates of L=4
and K=25.Is this an efficient input combination? if not determine the efficient input
combination for an output rate of 200.What is the capital -labor ratio?

It is not efficient input combination as does not response with expansion path.To find the
efficient one lets to solve the system of equation.

200 =20√K√L

200 =20√K √(1.25K) [L =1.25K]

K = 8.93

L =1.25 x8.93 =11.16

8.93 ×5
Capital labor ratio = =1
11.16 × 4

c)If the price of labor increases from $4 to $8 per unit determine the efficient input
combination for an output rate of 200.what is the capital labor ratio now? What input
substitution has the firm made.

K/L =8/5
200 =20√K√L

200 =20√K√(0.625K)

200 = 15.8K

K =12.65

L= 0.625 x12.65 = 7.91

12.65× 5
Capital labor ratio = =1
7.91× 8

Firm increased the capital by 42% and reduced the labor by 29%