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Problem Set 2 Solutions: Q L E L 1/4 2 L 1/4

This document summarizes solutions to Problem Set 2. 1. It provides the inverse demand curve formula and calculations for the energy market equilibrium with and without a tax. It also notes that long-run factor demand is expected to be more elastic as firms invest in technology. 2. It shows the calculations for average and marginal product of labor and marginal rate of technical substitution between labor and energy. Taking the derivatives of the profit function gives the first order conditions and solving them determines the cost-minimizing input ratio. 3. A figure illustrates that a substitution effect from a change in relative prices unambiguously increases energy and decreases labor, while a scale effect from a change in absolute prices increases both inputs as production expands

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52 views2 pages

Problem Set 2 Solutions: Q L E L 1/4 2 L 1/4

This document summarizes solutions to Problem Set 2. 1. It provides the inverse demand curve formula and calculations for the energy market equilibrium with and without a tax. It also notes that long-run factor demand is expected to be more elastic as firms invest in technology. 2. It shows the calculations for average and marginal product of labor and marginal rate of technical substitution between labor and energy. Taking the derivatives of the profit function gives the first order conditions and solving them determines the cost-minimizing input ratio. 3. A figure illustrates that a substitution effect from a change in relative prices unambiguously increases energy and decreases labor, while a scale effect from a change in absolute prices increases both inputs as production expands

Uploaded by

kelerong
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Problem Set 2 Solutions

1.
a) M RP = M R M P = 10 (12 2E) = 120 20E. So the
inverse demand curve is P = 120 20E.
b) E = 4.5 when P = 30.
c) E = 4.4 when P = 30 + and = 2.
d) In the long run we would expect factor demand to be more
elastic. Firms are likely to make investments in technology
that would make the firm less reliant on a single (volatile)
energy source.
2.
a) AP L =

q
L

b) M P L =


E 1/4
L

q
L

3
4

2
L1/4


E 1/4
L

c) M RT SL,E = FFEL = 3 E
L
c) The firms profit function is = L3/4 E 1/4 3LrE. Taking
the derivatives with respect to L and E gives us the two first
order conditions (FOCs),
1
4


L 3/4
E

=r

3
4


E 1/4
L

=3

Dividing the first FOC by the second and setting L = E


yields the answer, r = 1.
3.

L
80

70

60

50

40

30

20

C
A

10

0
10

20

30

40

50

60

a) The figure above shows that the substitution effect (moving


from A to B) unambiguously increases E and decreases L.
b) In the figure above, the scale effect (moving from B to C)
increases both E and L as the firm responds to the lower
prices by expanding production.
c) Since the price of energy falls in both relative and absolute
terms, we can say that the firm will use more energy. However, since the price of labor only falls in absolute terms, the
change in the firms labor use is ambiguous.

70

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