PROBLEMS OF

CHAPTER 7
COST MINIMIZATION AND INPUT DEMAND
Appendix to Chapter 7
Production and Cost Theory—A Mathematical Treatment

Cost Minimization
If there are two inputs, capital K and labor L, the production function F(K, L)
describes the maximum output that can be produced for every possible
combination of inputs. Writing the marginal product of capital and labor
as MPK(K, L) and MPL(K, L), respectively, it follows that

The cost-minimization problem can be written as

(A7.1)

subject to the constraint that a fixed output q0 be produced:

(A7.2)
• Step 1: Set up the Lagrangian.
(A7.3)
• Step 2: Differentiate the Lagrangian with respect to K, L, and λ and set
equal to zero.

(A7.4)

•Step 3: Combine the first two conditions in (A7.4) to obtain

(A7.5)

Rewrite the first two conditions in (A7.4 to evaluate the Lagrange multiplier:

(A7.6)

r/MPK(K, L) measures the additional input cost of producing an additional unit of output
by increasing capital, and w/MPL(K, L) the additional cost of using additional labor as an
input. In both cases, the Lagrange multiplier is equal to the marginal cost of production.
Marginal Rate of Technical Substitution

Write the isoquant: (A7.7)

Rearrange terms: (A7.8)

Rewrite the condition given by (A7.5) to get

(A7.9)

Rewrite (A7.9): (A7.10)

Duality in Production and Cost Theory

The dual problem asks what combination of K and L will let us produce the
most output at a cost of C0.

(A7.11)

• Step 1: Set up the Lagrangian.

(A7.12)
 (A7.13)

• Step 3: Combine the first two equations:

(A7.14)

This is the same result as (A7.5)—that is, the necessary condition for cost
minimization.
The Cobb-Douglas Cost and Production Functions

● Cobb-Douglas production function Production function of the

form q = AK Lβ, where q is the rate of output, K is the quantity of capital, and
L is the quantity of labor, and where A, , and β are positive constants.

We assume that a < 1 and β < 1, so that the firm has decreasing marginal
products of labor and capital.2 If + β = 1, the firm has constant returns to
scale, because doubling K and L doubles F. If + β > 1, the firm has
increasing returns to scale, and if + β < 1, it has decreasing returns to scale.

To find the amounts of capital and labor that the firm should utilize to minimize
the cost of producing an output q0, we first write the Lagrangian

(A7.15)

Differentiating with respect to L, K, and λ, and setting those derivatives equal

to 0, we obtain
(A7.16)
(A7.17)
(A7.18)
From equation (A7.16) we have
(A7.19)
Substituting this formula into equation (A7.17) gives us
(A7.20)
or
(A7.21)

A7.21 is the expansion path. Now use Equation (A7.21) to substitute for L in
equation (A7.18):
(A7.22)

We can rewrite the new equation as:

(A7.23)

or
(A7.24)
(A7.24) is the factor demand for capital. To determine the cost-
minimizing quantity of labor, we simply substitute equation (A7.24) into
equation (A7.21):
(A7.25)

The total cost of producing any output q can be obtained by substituting

equations (A7.24) for K and (A7.25) for L into the equation C = wL + rK. After
some algebraic manipulation we find that

(A7.26)

This cost function tells us (1) how the total cost of production increases as the
level of output q increases, and (2) how cost changes as input prices change.
When + β equals 1, equation (A7.26) simplifies to
(A7.27)
The firm’s cost function contains many desirable features. To
appreciate this fact, consider the special constant returns to scale cost
function (A7.27). Suppose that we wish to produce q0 in output but are
faced with a doubling of the wage. How should we expect our costs to
change? New costs are given by

If a firm suddenly had to pay more for labor, it would substitute away from labor
and employ more of the relatively cheaper capital, thereby keeping the increase
in total cost in check.
 Production and Cost Theory—A Mathematical Treatment
Cost Minimization/profit max
/output max/revenue max
 Cost Minimization/profit max

Q = 25L0.6K0.4,
where Q = output measured in one thousand carton lots, L = labor measured in person hours, and K =
capital measured in machine hours. Acme currently pays a wage of $10 per hour and considers the
relevant rental price for capital to be $25 per hour. Determine the optimal capital-labor ratio

MRTS =

MRTS = = 1.5 ∙

Equate MRTS to .
MRTS = 1.5

1.5 =

1.5 = 0.4

1.5K = 0.4L; K=0.266L

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Cost Minimization/profit max

12
 Cost Curves
30) Complete the following table:

Total Variable Fixed Marginal

Output Cost Cost Cost Cost
0 60
1 10
2 90
3 100
4 80
5 180
6 50
Answer:
Total Variable Fixed Marginal
Output Cost Cost Cost Cost
0 60 0 60 -
1 70 10 60 10
2 90 30 60 20
3 110 50 60 20
4 140 80 60 30
5 180 120 60 40
6 230 170 60 50

G.Das Micro 1 Spring Chapter 7 13

Cost Curves A firm's total cost function is given by the equation:
TC = 4000 + 5Q + 10Q2.
(1) Write an expression for each of the following cost concepts:

a. Total Fixed Cost

b. Average Fixed Cost
c. Total Variable Cost
d. Average Variable Cost
e. Average Total Cost
f. Marginal Cost

(2) Determine the quantity that minimizes average total cost. Demonstrate that the predicted
relationship between marginal cost and average cost holds.
ATC is minimized where MC is equal to ATC.

Equating MC to ATC

= 5 + 20Q

4000 +5Q + 102 = 5Q + 20Q2

4000 = 10Q2
Q2 = 400
Q = 20

ATC is minimized at 20 units of output. Up to 20, ATC falls, while beyond 20 ATC rises.
MC should be less than ATC for any quantity less than 20.
For example, let Q = 10:
MC = 5 + 20(10) = 205

ATC = = 505

MC is indeed less than ATC for quantities smaller than 20.

MC should exceed ATC for any quantity greater than 20.
For example, let Q = 25:
MC = 5 + 20(25) = 505

ATC = = 415
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MC is indeed greater than ATC for quantities greater than 20.
Cost Minimization/profit max

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