ECON 301 Homework Chapter 5

1. A firm can manufacture a product according to the production function:

Q = F(K,L) = K3/4L1/4.

a. Calculate the average product of labor, APL, when the level of capital is fixed at 81 units and
the firm uses 16 units of labor.

Instruction: Round your responses to 3 decimal places.

What is the average product of labor when the firm uses 256 units of labor?

b. Find an expression for the marginal product of labor, MPL, when the amount of capital is
fixed at 81 units.

Instruction: The second response is the exponent on L in the expression. Round your responses to
2 decimal places.

MPL = *L ^

Then, illustrate that the marginal product of labor depends on the amount of labor hired by
calculating the marginal product of labor for 16 and 81 units of labor.

Instruction: Round your responses to 3 decimal places.

MPL when L = 16:

MPL when L = 81:

c. Suppose capital is fixed at 81 units. If the firm can sell its output at a price of $200 per unit
and can hire labor at $50 per unit, how many units of labor should the firm hire in order to
maximize profits?

Instruction: Enter your response as a whole number.

Explanation:
a. When K = 81 and L = 16, Q = (81)0.75(16)0.25 = 54. Thus, APL = Q/L = 54/16 = 3.375.
When K = 81 and L = 256, Q = (81)0.75(256)0.25 = (27)(4) = 108. Thus, APL = 108/256 =
0.422.

b. The marginal product of labor is MPL = (1/4)*(81)0.75(L)-3/4 = 6.75*(L)-0.75. When L = 16,

MPL = 6.75*(16)-0.75 = 0.844. When L = 81, MPL = 6.75*(81)-0.75 = 0.25. Thus, as the
number of units of labor hired increases, the marginal product of labor decreases MPL(16) =
0.844 > 0.250 = MPL(81), holding the level of capital fixed.

c. We must equate the value marginal product of labor to the wage and solve for L. Here, VMPL
= (P)(MPL) = ($200)(6.75)(L)-0.75=1350(L)-0.75. Setting this equal to the wage of $50 gives
1350(L)-0.75 = 50. Solving for L, the optimal quantity of labor is L = 81.

2. The decline in marginal productivity experienced when input usage increases, holding all other
inputs constant, is known as:

The law of diminishing marginal returns.

A property of a production function stating that as less of one input is used, increasing amounts
of another input must be employed to produce the same level of output, is known as:

The law of diminshing marginal rate of technical substitution.

Explanation:
The first is the law of diminishing marginal returns, and the second is the law of diminishing
marginal rate of technical substitution.

3. An economist estimated that the cost function of a single-product firm is:

C(Q) = 100 + 20Q + 15Q2 + 10Q3.

Based on this information, determine the following:

a. The fixed cost of producing 10 units of output.

b. The variable cost of producing 10 units of output.

c. The total cost of producing 10 units of output.

d. The average fixed cost of producing 10 units of output.

e. The average variable cost of producing 10 units of output

f. The average total cost of producing 10 units of output.

g. The marginal cost when Q = 10.

Explanation:
a. FC = $100.

b. VC(10) = 20(10) + 15(10)2 + 10(10)3 = $11,700.

c. C(10) = 100 + 20(10) + 15(10)2 + 10(10)3 = $11,800.

d. AFC(10) = $100 / 10 = $10.

e. AVC(10) = VC(10) / 10 = $11,700 / 10 = $1,170.

f. ATC(10) = AFC(10) + AVC(10) = $1,180.

g. MC(10) = 20 + 30(10) + 30(10)2 = $3,320.

4. A manager hires labor and rents capital equipment in a very competitive market. Currently the
wage rate is $12 per hour and capital is rented at $8 per hour. If the marginal product of labor is
60 units of output per hour and the marginal product of capital is 45 units of output per hour,
should the firm increase, decrease, or leave unchanged the amount of capital used in its
production process?

The firm should increase capital.

Explanation:
Since MRTSKL ≠ w / r, the firm is not using the cost minimizing combination of labor and
capital. To minimize costs, the firm should increase capital (and decrease labor) since the
marginal product per dollar spent is greater for capital: (MPK / r) = (45 / 8) > (MPL / w) = (60 /
12).

5. A firm’s fixed costs for 0 units of output and its average total cost of producing different
output levels are summarized in the table below. Complete the table to find the fixed cost,
variable cost, total cost, average fixed cost, average variable cost, and marginal cost at all
relevant levels of output.Explanation:
See table below:

(1) (2) (3) (4) (5) (6) (7) (8)

 Average
Variable Average Average Marginal
Quantity Fixed Cost Total Cost Variable
Cost Fixed Cost Total Cost Cost
Q FC TC Cost
VC AFC ATC MC
AVC

0 15,000 0 15,000 - - - -

100 15,000 15,000 30,000 150.00 150.00 300 150

200 15,000 25,000 40,000 75.00 125.00 200 100

300 15,000 37,500 52,500 50.00 125.00 175 125

400 15,000 75,000 90,000 37.50 187.50 225 375

500 15,000 147,500 162,500 30.00 295.00 325 725

600 15,000 225,000 240,000 25.00 375.00 400 775

6. A multiproduct firm’s cost function was recently estimated as:

C(Q1,Q2) = 90 - 0.5Q1Q2 +0.4Q12 + 0.3Q22

a. Are there economies of scope in producing 10 units of product 1 and 10 units of product 2?

Yes - there are economies of scope.

b. Are there cost complementarities in producing products 1 and 2?

Yes - there are cost complementarities.

c. Suppose the division selling product 2 is floundering and another company has made an offer
to buy the exclusive rights to produce product 2. How would the sale of the rights to produce
product 2 change the firm’s marginal cost of producing product 1?

Marginal cost would increase.

Explanation:
a. For a quadratic multi-product cost function, economies of scope exist if f – aQ1Q2 > 0. In this
case, f = 90 and a = -0.5, so economies of scope exist since f is fixed cost, which is always
nonnegative.

b. Cost complementarities exist since a = -0.5 < 0, which holds in this case.

c. Since a = -0.5 < 0, the marginal cost of producing product 1 will increase if the division that
produces product 2 is sold.
7. A firm produces output according to a production function:

Q = F(K,L) = min {4K,8L}.

a. How much output is produced when K = 2 and L = 3?

b. If the wage rate is $60 per hour and the rental rate on capital is $20 per hour, what is the cost-
minimizing input mix for producing 8 units of output?

Capital:
Labor:

c. How does your answer to part b change if the wage rate decreases to $20 per hour but the
rental rate on capital remains at $20 per hour?

It does not change.

Explanation:
a. When K = 2 and L = 3, Q = 8 units.

b. The cost-minimizing mix of K and L that produce Q = 8 is K = 2, L = 1.

c. Since K and L are perfect complements in the production process, the cost-minimizing levels
of K and L do not depend on the rental rates of K and L. Therefore, the cost-minimizing levels of
K and L do not change with changes in the relative rental rates.

8. A firm produces output according to the production function:

Q = F(K,L) = 4K + 8L.

a. How much output is produced when K = 2 and L = 3?

b. If the wage rate is $60 per hour and the rental rate on capital is $20 per hour, what is the cost-
minimizing input mix for producing 32 units of output?

Capital:
Labor:

c. If the wage rate decreases to $20 per hour but the rental rate on capital remains at $20 per
hour, what is the cost-minimizing input mix for producing 32 units of output?

Capital:
Labor:
Explanation:
a. With K = 2 and L = 3, Q = 4(2) + 8(3) = 32.

b. Since the MRTSKL is 8/4 = 2, that means a company can trade two units of capital for every
one unit of labor. This production function does not exhibit diminishing marginal rate of
technical substitution. The perfect substitutability between capital and labor means that only one
input will be utilized. Since MPL / w = 8 / 60 < 4 / 20 = MPK / r, the company should hire all
capital. To get 32 units of output, this will require 8 units of capital.

c. Here, we have MPL / w = 8 / 20 > 4 / 20 = MPK / r, so the company should hire only labor. To
get 32 units of output, this will require 4 units of labor.

9. You were recently hired to replace the manager of the Roller Division at a major conveyor-
manufacturing firm, despite the manager’s strong external sales record. Roller manufacturing is
relatively simple, requiring only labor and a machine that cuts and crimps rollers. As you begin
reviewing the company’s production information, you learn that labor is paid $12 per hour and
the last worker hired produced 80 rollers per hour. The company rents roller cutters and crimping
machines for $15 per hour, and the marginal product of capital is 110 rollers per hour.

Should you change the mix of capital and labor, and if so, how should it change?

You should increase capital and decrease labor.

Explanation:
Since MRTSKL ≠ w / r, the firm was not using the cost minimizing combination of labor and
capital. To achieve the cost minimizing combination of inputs, you should use more units of
capital and fewer units of labor, since MPL / w = 80 / 12 < MPK / r = 110 / 15.

10. You are a manager for Herman Miller—a major manufacturer of office furniture. You
recently hired an economist to work with engineering and operations experts to estimate the
production function for a particular line of office chairs. The report from these experts indicates
that the relevant production function is:

Q = 2(K)1/2(L)1/2

where K represents capital equipment and L is labor. Your company has already spent a total of
$8,000 on the 9 units of capital equipment it owns. Due to current economic conditions, the
company does not have the flexibility needed to acquire additional equipment. If workers at the
firm are paid a competitive wage of $120 and chairs can be sold for $400 each, what is your
profit-maximizing level of output and labor usage?

Output:
Labor:

What is your maximum profit?

Explanation:
The profit-maximizing level of labor and output is achieved where VMPL = w. Here, VMPL =
(1/2)2($400)(9)1/2(L)-1/2 = $1,200(L)-1/2 and w = $120 per day. Solving yields L = 100. The
profit-maximizing level of output is Q = 2(9)1/2(100)1/2 = 60 units. The firm’s fixed costs are
$8,000, its variable costs are $120(100) = $12,000, and its total revenues are $400(60) =
$24,000. Profits are $24,000 – $12,000 – $8,000 = $4,000.

11. According to The Wall Street Journal, Mitsubishi Motors recently announced a major
restructuring plan in an attempt to reverse declining global sales. Suppose that as part of the
restructuring plan Mitsubishi conducts an analysis of how labor and capital are used in its
production process. Prior to restructuring Mitsubishi’s marginal rate of technical substitution is
0.12 (in absolute value). To hire workers, suppose that Mitsubishi must pay the competitive
hourly wage of ¥1,800. In the study of its production process and markets where capital is
procured, suppose that Mitsubishi determines that its marginal productivity of capital is 0.8 small
cars per hour at its new targeted level of output and that capital is procured in a highly
competitive market. The same study indicates that the average selling price of Mitsubishi’s
smallest car is ¥1,200,000. Determine the rate at which Mitsubishi can rent capital and the
marginal productivity of labor at its new targeted level of output.

Instruction: Round your answer for marginal productivity of labor to 4 decimal places.

Rental rate of capital: ¥

Marginal productivity of labor:

To minimize costs Mitsubishi should hire capital and labor until the marginal rate of technical
substitution reaches what proportion?

Instruction: Round your answer to 4 decimal places.

Explanation:
The rental rate of capital is ¥960,000, computed as r = MPK*P = 0.8*1,200,000 = 960,000.
Therefore, the marginal product of labor is 0.0015 cars per hour, which is found by solving
MPL / 1,800 = 0.8 / 960,000. Costs are minimized when the marginal rate of technical
substitution is 0.0019 = w / r = 1,800 / 960,000.

12. In the aftermath of a hurricane, an entrepreneur took a one-month leave of absence (without
pay) from her $5,000 per month job in order to operate a kiosk that sold fresh drinking water.
During the month she operated this venture the entrepreneur paid the government $2,500 in
kiosk rent and purchased water from a local wholesaler at a price of $1.34 per gallon. If
consumers were willing to pay $2.25 to purchase each gallon of fresh drinking water, how many
units did she have to sell in order to turn an economic profit?

Explanation:
Taking into account both implicit and explicit costs, the total fixed cost from operating the kiosk
is $7,500 (the $2,500 in rent plus the $5,000 in forgone earnings.) Total variable costs are $1.34
times the number of gallons. The cost function is C(Q) = 7,500 + 1.34Q. The entrepreneur will
earn a profit when revenues exceed costs, which occurs when 2.25Q > 7,500 + 1.34Q. Solving
for Q implies the entrepreneur earns a profit when she sells Q > 8,242 gallons (rounding up).