In-Class Practice Questions

Theory of Firm and Production

 Q1. Why is the might the marginal product of labor
likely to initially increase initially in the short run as
more of the variable input is hired?

• The marginal product of labor is likely to can initially increase

initially because there are gains to specialization, such that
when there are more workers, each worker is able to specialize
on one aspect of the production process in which he or she is
particularly skilled.

• For example, think of the typical fast food restaurant. If there is

only one worker, he will need to prepare the burgers, fries, and
sodas, as well as take the orders. Only so many customers can
be served in an hour. With two or three workers, each is able to
specialize and the marginal product (number of customers
served per hour) is likely to increase as we move from one to
two to three workers. Eventually, there will be enough workers
and there will be no more gains from specialization. At this
point, the marginal product will diminish.
 Q2a. You are an employer seeking to fill a vacant
position on an assembly line. Are you more concerned
with the average product of labor or the marginal
product of labor for the last person hired?

• In filling a vacant position, you should be

concerned with the marginal product of the last
worker hired because the marginal product
measures the effect on output, or total product,
of hiring another worker. This in turn will help to
determine the revenue generated by hiring
another worker, which can then be compared to
the cost of hiring another worker.
 Q2b. If you observe that your average product is just
beginning to decline, should you hire any more
workers? What does this situation imply about the
marginal product of your last worker hired?

• The point at which the average product begins

to decline is the point where average product is
equal to marginal product. When average
product declines, the marginal product of the last
worker hired is lower than the average product
of previously hired workers.
• Although adding more workers results in a
further decline in average product, total product
continues to increase, so it may still be
advantageous to hire another worker.
Q.3 The menu at Joe’s coffee shop consists of a variety of coffee espresso
type drinks, pastries, and sandwiches. The marginal product of an
additional worker can be defined as the number of customers that can be
served by that worker in a given time period. Joe has been employing one
worker, but is considering hiring a second and a third. Explain why the
marginal product of the second and third workers might be higher than the
first and second workers, respectively. Why might would you expect the
marginal product of an additional workers to eventually diminish in this
case?

• The Marginal product could well may increase for the

second and third workers, since each of the first 2 or 3
workers would be able to specialize in a different task. If
there is only 1 worker, then that worker will have to take
orders and prepare all the food. Eventually, however,
the marginal product would diminish because there
would be too many people behind the counter trying to
accomplish the a limited number of tasks.
Q.4 Suppose a chair manufacturer is producing in the short run
(with its existing plant and equipment). The manufacturer has
observed the following levels of production corresponding to
different numbers of workers:
Number of chairs Number of workers
1 10
2 18
3 24
4 28
5 30
6 28
7 25

• a. Calculate the marginal and average product of labor for this

production function.
• b. Does this production function exhibit diminishing returns to labor?
Explain.
• c. Explain intuitively what might cause the marginal product of labor
to become negative.
Answer for a.
L Q APL MPL

0 0 __ __
1 10 10 10
2 18 9 8
3 24 8 6
4 28 7 4
5 30 6 2
6 28 4.7 -2
7 25 3.6 -3
 Answer for b.
• This production process exhibits
diminishing returns to labor. The marginal
product of labor, the extra output produced
by each additional worker, diminishes as
workers are added, and is actually
negative for the sixth and seventh
workers.
 Answer for c.
• Labor’s negative marginal product for L > 5 may
arise from congestion in the chair
manufacturer’s factory. Since more laborers are
using the same, fixed amount of capital, it is
possible that they could get in each other’s way,
decreasing efficiency and the amount of output.
Many firms also have to control the quality of
output and the high congestion of labor may
produce output that is not of a high enough
quality to be offered for sale, which can
contribute to a negative marginal product.
 Q5. Fill in the gaps in the table below.

Quantity of Total Marginal Product Average Product

Variable Input Output of Variable Input of Variable Input

0 0 ___ ___
1 225
2 300
3 300
4 1140
5 225
6 225
 Answer to Q5
Quantity of Total Marginal Product Average Product
Variable Input Output of Variable Input of Variable Input

0 0 ___ ___
1 225 225 225
2 600 375 300
3 900 300 300
4 1140 240 285
5 1365 225 273
6 1350 -15 225
 Q6. The marginal product of labor in the production of
computer chips is 50 chips per hour. The marginal rate of
technical substitution of hours of labor for hours of machine-
capital is 1/4. What is the marginal product of capital?

To determine the marginal product of capital, substitute the given values for the
marginal product of labor and the marginal rate of technical substitution into the
following formula:
MPL 50 1 or
= MRTS, or = ,
MPK MPK 4
MPK = 200 computer chips per hour.
 Q7. Do the following functions exhibit increasing, constant, or
decreasing returns to scale? What happens to the marginal
product of each individual factor as that factor is increased, and
the other factor is held constant at some level?

q = 3L + 2K

This function exhibits constant returns to scale.

For example, if L is 2 and K is 2 then q is 10. If L is 4 and
K is 4 then q is 20.
When the inputs are doubled, output will double.
Each marginal product is constant for this production
function.
When L increases by 1 q will increase by 3. When K
increases by 1 q will increase by 2.
 1

q = (2L + 2K ) 2

• This function exhibits decreasing returns to scale. For example, if L

is 2 and K is 2 then q is 2.8. If L is 4 and K is 4 then q is 4. When
the inputs are doubled, output will less than double. The marginal
product of each input is decreasing.
• For example, the marginal product of labor is:

∂q 2
=
∂L 1

2(2L + 2K) 2

Since L is in the denominator, as L gets bigger, the marginal product

gets smaller.

For example, if L=4 and K=4 then q=4. If L=5 and K=4 then q=4.24.
If L=6 and K=4 then q= 4.47.
Marginal product of labor falls from 0.24 to 0.23.
 q = 3LK 2

• This function exhibits increasing returns to scale. For example, if L is

2 and K is 2 then q is 24. If L is 4 and K is 4 then q is 192. When the
inputs are doubled, output will more than double.
• if we increase each input by the same factor λ then we get:

q'= 3(λ L)(λK ) = λ 3LK = λ q 2 3 2 3

Since is raised to a power greater than 1, we have increasing returns to scale.

The marginal product of labor is constant and

the marginal product of capital is increasing.
For any given value of K, when L is increased by 1 unit, q will go up by 3K2
units, which is a constant number.
Using calculus, the marginal product of capital is MPK=2*3*L*K.
As K increases, MPK will increase.
 1 1

q = L K 2 2

1 1 1 1

q'= (λ L) 2 (λ K ) 2 = λL2K 2 = λq
This function exhibits constant returns to scale.
For example, if L is 2 and K is 2 then q is 2. If L is 4 and K is 4 then q is 4.
When the inputs are doubled, output will exactly double.
1

L2
MPK = 1

2K 2

Let L=4 for example. If K is 4 then q is 4, if K is 5 then q is 4.47,

and if K is 6 then q is 4.89.
The marginal product of the 5th unit of K is 4.47-4=0.47,
and the marginal product of the 6th unit of K is 4.89-4.47=0.42.
Hence we have diminishing marginal product of capital.
 Questions 8

• Can an isoquant • Explain the term “marginal rate of technical substitution.” What
does a MRTS = 4 mean?
ever slope upward?
Explain. • MRTS is the amount by which the quantity of one input can be reduced
when the other input is increased by one unit, while maintaining the
• No. An upward same level of output. If the MRTS is 4 then one input
sloping isoquant can be reduced by 4 units as the other is increased by one unit, and
output will remain the same.
would mean that if
you increased both • Explain why the marginal rate of technical substitution is likely to
diminish as more and more labor is substituted for capital.
inputs output would
stay the same. This • As more and more labor is substituted for capital, it becomes
increasingly difficult for labor to perform the jobs previously done by
would occur only if capital. Therefore, more units of labor will be required to replace each
one of the inputs unit of capital, and the MRTS will diminish. For example, think of
reduced output; sort employing more and more farm labor while reducing the number of
of like a bad in tractor hours used. At first you would stop using tractors for simpler
tasks such as driving around the farm to examine and repair fences or
consumer theory. to remove rocks and fallen tree limbs from fields. But eventually, as
As a general rule, if the number or labor hours increased and the number of tractor hours
the firm has more declined, you would have to plant and harvest your crops primarily by
hand. This would take huge numbers of additional workers.
of all inputs it can
produce more
output.
 Question 9

• Is it possible to have diminishing returns to a single • Suppose that output q is a

factor of production and constant returns to scale at the function of a single input,
same time? Discuss. labor (L). Describe the returns
to scale associated with each of
• Diminishing returns and returns to scale are completely the following production
different concepts, so it is quite possible to have both functions:
diminishing returns to, say, labor and constant returns to
scale. Diminishing returns to a single factor occurs because • a. q = L/2.
all other inputs are fixed. Thus, as more and more of the
variable factor is used, the additions to output eventually • b. q = L2 + L.
become smaller and smaller because there are no increases
in the other factors. The concept of returns to scale, on the • c. q = log(L).
other hand, deals with the increase in output when all
factors are increased by the same proportion. While each
factor by itself exhibits diminishing returns, output may
more than double, less than double, or exactly double when
all the factors are doubled. The distinction again is that with
returns to scale, all inputs are increased in the same
proportion and no inputs are fixed. The production function
in Exercise 10 is an example of a function with
diminishing returns to each factor and constant returns to
 Answers

• a. q = L/2. Let q′ be output when labor is doubled to 2L. Then q′ = (2L)/2

= L. Compare q′ to q by dividing q′ by q. This gives us q′/q = L/(L/2) = 2.
Therefore when the amount of labor is doubled, output is also doubled.
Hence there are constant returns to scale.
• b. q = L2 + L. Again, let q′ be output when labor is doubled. q′ = (2L)2 +
2L = 4L2 + 2L. Dividing by q yields q′/q = (4L2 + 2L)/(L2 + L) > 2. To see
why this ratio is greater than two, note that it would be exactly two if q′
were to equal 2L2 + 2L, but q′ is larger than that, so the ratio is greater than
two, indicating increasing returns to scale.
• c. q = log(L). In this case, q′ = log(2L) = log(2) + log(L), using the rules
for logarithms. Then q′/q = [log(2) + log(L)]/log(L) = log(2)/log(L) + 1.
This expression is greater than, equal to or less than 2 when L is less than,
equal to or greater than 2. So this production function exhibits increasing
returns to scale when L < 2, constant returns to scale when L = 2, and
decreasing returns to scale when L > 2.
•
 Question 10
• Suppose life expectancy in years (L) is a function of two inputs, health
expenditures (H) and nutrition expenditures (N) in hundreds of dollars per
year. The production function is
L = cH0.8N0.2.
• a. Beginning with a health input of $400 per year (H = 4) and a nutrition input
of $4900 per year (N = 49), show that the marginal product of health expenditures
and the marginal product of nutrition expenditures are both decreasing.
• b. Does this production function exhibit increasing, decreasing, or constant
returns to scale?
• Suppose that in a country suffering from famine, N is fixed at 2 and that c = 20.
Plot the production function for life expectancy as a function of health
expenditures, with L on the vertical axis and H on the horizontal axis.
• Now suppose another nation provides food aid to the country suffering from
famine so that N increases to 4. Plot the new production function.
 Answers
• a. When H = 4 and N = 49, L = c(40.8)(490.2) = 6.602c. Holding N constant at 49,
when H = 5,
L = 7.893c, and when H = 6, L = 9.132c. The marginal product of H drops from
1.291c
(7.893c − 6.602c) to 1.239c (9.132c − 7.893c). Therefore the marginal product of
health expenditures is decreasing.
• Now hold H constant at 4 and increase N to 50. L = c(40.8)(500.2) = 6.629c.
Increasing N to 51,
L = 6.655c. The marginal product of N drops from 0.027c (6.629c − 6.602c) to
0.026c
(6.655c − 6.629c), so the marginal product of nutrition expenditures is decreasing.
• b. There are constant returns to scale. If both inputs are doubled, the new output is
L′ = c(2H)0.8(2N)0.2 = cH0.8N0.2(20.8)(20.2) = 2cH0.8N0.2 = 2L. So when both inputs
are doubled,
life expectancy also doubles. Hence there are constant returns to scale.
• c. The production function becomes L = 20(H0.8)(20.2) = 22.974H0.8. To plot this,
find the life expectancies for various levels of H, plot those points and draw a
smooth curve through them. Here are some points: H = 1 and L = 22.97; H = 2 and
L = 40.00; H = 3 and L = 55.38; H = 4 and L = 69.64; H = 5 and L = 83.26. This
production function is plotted below as a dashed line.
 Answers
• d. Now suppose another nation provides food aid to the country suffering from famine
so that N increases to 4. Plot the new production function.
• The production function becomes L = 20(H0.8)(40.2) = 26.390H0.8. Points to plot are H = 1 and
L = 26.39; H = 2 and L = 45.95; H = 3 and L = 63.55; H = 4 and L = 80.00; H = 5 and L =
95.63. This production function is plotted below as a solid line.