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    Problem Set 3 - Answers

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    Vincent Liow
    The document discusses demand and supply functions for Eye-de-ho potatoes. It provides the specific functions and defines the variables in the functions. It then analyzes the functions at given values for the variables and finds the equilibrium price and quantity. The document also examines a production function, finding it exhibits constant returns to scale. It shows the production function displays diminishing marginal returns for both capital and labor. Finally, it calculates the marginal rate of technical substitution for the production function.

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    Problem Set 3 - Answers

    Uploaded by

    Vincent Liow
    98 views3 pages
    The document discusses demand and supply functions for Eye-de-ho potatoes. It provides the specific functions and defines the variables in the functions. It then analyzes the functions at given values for the variables and finds the equilibrium price and quantity. The document also examines a production function, finding it exhibits constant returns to scale. It shows the production function displays diminishing marginal returns for both capital and labor. Finally, it calculates the marginal rate of technical substitution for the production function.

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    The document discusses demand and supply functions for Eye-de-ho potatoes. It provides the specific functions and defines the variables in the functions. It then analyzes the functions at given values for the variables and finds the equilibrium price and quantity. The document also examines a production function, finding it exhibits constant returns to scale. It shows the production function displays diminishing marginal returns for both capital and labor. Finally, it calculates the marginal rate of technical substitution for the production function.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    98 views3 pages

    Problem Set 3 - Answers

    Uploaded by

    Vincent Liow
    The document discusses demand and supply functions for Eye-de-ho potatoes. It provides the specific functions and defines the variables in the functions. It then analyzes the functions at given values for the variables and finds the equilibrium price and quantity. The document also examines a production function, finding it exhibits constant returns to scale. It shows the production function displays diminishing marginal returns for both capital and labor. Finally, it calculates the marginal rate of technical substitution for the production function.

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    © All Rights Reserved
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    of 3

    Problem Set-3

    P3.1

    Demand and supply functions for Eye-de-ho Potatoes are as follows:

    QD = -1,450 - 25P + 12.5PW + 0.1Y, (Demand)

    QS = -100 + 75P - 25PW - 12.5PL + 10R, (Supply)


    Where
    P is the average wholesale price of Eye-de-ho Potatoes ($ per bushel),
    PW is the average wholesale price of wheat ($ per bushel),
    Y is income (GDP in $ billions),
    PL is the average price of unskilled labor ($ per hour)
    R is the average annual rainfall (in inches).

    Both QD and QS are in millions of bushels of potatoes.

    A. At PW = $4, Y = $15,000 billion, PL = $8, and R = 20 inches

    QD = -1,450 – 25*P + 12.5*4 + 0.1*15000 = 100 -25P


    QS = -100 + 75P – 25*4 - 12.5*8 + 10*20 = -100+75P

    B.
    Quanity in millions
    Price, $ Quantity Supplied, QS Quantiy Surplus or
    Demaned, QD Shortage,
    millions
    1.5 12.5 62.5 Shortage by 50
    2 50 50 Equilibrium
    2.5 87.5 37.5 Surplus by 50

    C.

    Equilibirum is when QD=QS

    100-25P=-100+75P
    100P=200
    P=2

    QD= 50 (millions), QS= 50 (millions)


    Q.2

    Consider the following production function: 𝑄 = 100(𝐾 0.8 𝐿0.2 )

    (a) Does this production function exhibit increasing, decreasing, or constant returns to scale?

    Show using a generalised formula.

    Using the formula

    Qx = 100(xK)0.8(xL)0.2 = 100x0.8(K)0.8x0.2(L)0.2=100x(K0.80L0.2)

    This shows if we increase all factors by x, the output will increase by x. Thus, there will be a
    constant returns to scale.

    (b) Show that capital and labour both exhibit diminishing marginal returns.

    K is fixed
    at 10
    Q = 100(K^0.8
    Labour L^0.2 MP
    20 1148.698355
    21 1159.962259 11.26390366
    22 1170.804913 10.84265431
    23 1181.260188 10.45527508
    24 1191.357898 10.09771012

    L is fixed
    at 5
    Q = 100(K^0.8
    Capital L^0.2 MP
    15 1084.471771
    16 1098.560543 14.08877211
    17 1111.961586 13.40104263
    18 1124.746113 12.7845272
    19 1136.974489 12.22837567

    We can see that the marginal products are decreasing when K and L increases.

    (c) Calculate the MRTS (of K for L).

    MRTS is the marginal rate of technical substitution, it is the absolute value of the slope on the isoquant. Rate of
    substitution

    𝑄 = 100(𝐾 0.8 𝐿0.2 )


    𝑑𝐾 𝑀𝑃𝐿 (100 ∗ 𝐾 0.8 ∗ 0.2 ∗ 𝐿−0.8 ) 𝐾
    𝑀𝑅𝑇𝑆 = − = = =
    𝑑𝐿 𝑀𝑃𝐾 (100 ∗ 0.8 ∗ 𝐾 −0.2 𝐿0.2 ) 4𝐿

    For any isoquant the MRTS is K/4L.

    P7.2 Production Function Concepts. Indicate whether each of the following statements is
    true or false. Explain your answers.

    A. Decreasing returns to scale and increasing average costs are indicated


    when
    εQ < 1.

    TRUE. This equation shows that if percentage change in output is less than the percentage
    change in all inputs increase, there is a diminishing returns to scale.

    B. If the marginal product of capital falls as capital usage grows, the returns
    to capital are decreasing.

    TRUE. The marginal product shows the effect of increasing 1 unit of capital. If capital grows
    by 1 unit but leads to a decrease in output then there is decreasing returns.

    C. L-shaped isoquants describe production systems in which inputs are


    perfect substitutes.

    False. The isoquant shows the inputs that can be used efficiently to produce a specified
    quantity of output. 


    D. Marginal revenue product measures the profit earned through expanding


    input usage.

    False. The marginal revenue product (MRP) is the additional net revenue generated by the
    last unit employed. To obtain profit, the MRP > MC

    E. The marginal rate of technical substitution will be affected by a given


    percentage increase in the marginal productivity of all inputs.

    𝑑𝐾 𝑀𝑃𝐿
    𝑀𝑅𝑇𝑆 = − =
    𝑑𝐿 𝑀𝑃𝐾

    False. The MRTS is the ratio of the two marginal products. Since we are using the ratio of
    two marginal products it would not matter.

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