Eric Stevanus - LA28 - 2201756600

1. A firm can manufacture a product according to the production function (LO1, LO2,
LO5, LO6)

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

a. Calculate the average product of labor, AP L, when the level of capital is fixed
at 81 units and the firm uses 16 units of labor. How does the average product
of labor change when the firm uses 256 units of labor?
3 1 3 1
Q = F(81,16) = 81 4 ×16 4 Q = F(81,256) = 81 4 ×256 4
= 27 ×2 =27 × 4
= 54 = 108
Average product of labor:
Q/L(16 units) = 54 / 16 Q/L(256 units) = 108 / 256
= 3,375 = 0,422

b. Find an expression for the marginal product of labor, MP L, when the amount
of capi- tal is fixed at 81 units. 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.

Q = F(81, L) = 813/4L1/4
= 27 L1/4
∆ Q 27 −34 27
MPL(81,L) = = L = 3
∆L 4 4 L4
27
MPL(81,16) = 3 = 0,84375
4 ×(16)4
27
MPL(81,81) = 3 = 0,25
4 ×(81) 4

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

Mazimize Profits : VMPL = w

: P x MPL(81,L) = w
27
Efficient Labor : $200 x 3 = $50
4 L4
3
: L4 = 27
:L = 81 Labors
 Eric Stevanus - LA28 - 2201756600

2. A firm’s product sells for $4 per unit in a highly competitive market. The firm
produces output using capital (which it rents at $25 per hour) and labor (which is paid
a wage of $30 per hour under a contract for 20 hours of labor services). Complete the
following table and use that information to answer these questions.

K L Q MPK APK APL VMPK

0 20 0 - - - -
1 20 50 50 50 2,5 200
2 20 150 100 75 7,5 400
3 20 300 150 100 15 600
4 20 400 100 100 20 400
5 20 450 50 90 22,5 200
6 20 475 25 79,17 23,75 100
7 20 475 0 67,86 23,75 0
8 20 450 -25 56,25 22,5 -100
9 20 400 -50 44,44 20 -200
10 20 300 -100 30 15 -400
11 20 150 -150 13,64 7,5 -600

a. Identify the fixed and variable inputs.

Fixed inputs : 20 hours of labor services (Labor)

Variable inputs : Rent hours (Capital)

b. What are the firm’s fixed costs?

Wage = $30 x 20 hours

= $600

c. What is the variable cost of producing 475 units of output?

Rent (6 hours) = $25 x 6 hours

= $150

d. How many units of the variable input should be used to maximize profits?

Maximize Profits ,if Marginal Product of Capital = 0

Variable input (Capital) =6

e. What are the maximum profits this firm can earn?

Max Profits π max = Revenue – Fixed Cost – Variable Cost

= (475 units x $4) - $150 – $600
 Eric Stevanus - LA28 - 2201756600
= $1.150

f. Over what range of the variable input usage do increasing marginal returns
exist?

From 0 to 3 variable input

g. Over what range of the variable input usage do decreasing marginal returns
exist?

From 3 to 11 variable input

h. Over what range of input usage do negative marginal returns exist?

From 7 to 11 variable input

3. Explain the difference between the law of diminishing marginal returns and the law of
diminishing marginal rate of technical substitution.

Law of Diminishing Marginal Return

The law of diminishing marginal returns is a theory in economics that predicts that after
some optimal level of capacity is reached, adding an additional factor of production will
actually result in smaller increases in output. The law of diminishing returns is related to the
concept of diminishing marginal utility. After some optimal level of capacity utilization, the
addition of any larger amounts of a factor of production will inevitably yield decreased per-
unit incremental returns

Law of Diminishing Marginal Rate of Technical Subtitution

The marginal rate of technical substitution (MRTS) is an economic theory that illustrates the
rate at which one factor must decrease so that the same level of productivity can be
maintained when another factor is increased. The marginal rate of technical substitution
shows the rate at which you can substitute one input, such as labor, for another input, such
as capital, without changing the level of resulting output. The isoquant, or curve on a graph,
shows all of the various combinations of the two inputs that result in the same amount of
output.

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

C(Q) = 230 + 12Q+ 8Q2 + 10Q3

Based on this information, determine:

a. The fixed cost of producing 7 units of output.

$230
 Eric Stevanus - LA28 - 2201756600
b. The variable cost of producing 7 units of output.

(12 x 7) + (8 x 49) + (10 x 343) = $3.906

c. The total cost of producing 7 units of output.

$3.906 + $230 = $4.136

d. The average fixed cost of producing 7 units of output.

$230 / 7 units = $32,86

e. The average variable cost of producing 7 units of output.

$3.906 / 7 units = $558

f. The average total cost of producing 7 units of output.

$4.136 / 7 units = $590,86

g. The marginal cost when Q = 7.

Marginal cost = 12 + 16Q +30Q2

Marginal cost(7units) = 12 +(16 x 7) + (30 x 49)
= 12 + 112 + 1470
= $1.594

5. 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, is the firm using the cost-minimizing
combination of labor and capital? If not, should the firm increase or decrease the
amount of capital used in its production process?

For the Capital Ratio = 45 units / $8 = 5,625

For the Labor Ratio = 60 units / $12 =5
These are not equal. The firm is getting higher amount on the last dollar spent on Capital
than it is getting from the last dollar spent on Labor. If the firm can,it should consume more
Capital and less Labor. Consuming less Labor will increase the marginal product of Labor to
some number larger than 60 units. Consuming more Capital will decrease the marginal
product of Capital to some number less than 45 units. Any substitution of Labor to Capital
will probably benefit the firm.

The firm should increase the amount of capital used in the production process.

6. A firm’s fixed costs for 0 units of output and its average total cost of producing
different output levels are summarized in the following table. Complete the table to
 Eric Stevanus - LA28 - 2201756600
find the fixed cost, variable cost, total cost, average fixed cost, average variable cost,
and marginal cost at all relevant levels of output.

Q FC VC TC AFC AVC ATC MC

0 $15,000 - - - - - -
100 $15,000 $15,000 $30.000 $150 $150 $300 $300
200 $15,000 $25,000 $40.000 $75 $125 $200 -$100
300 $15,000 $37,500 $52,500 $50 $125 $175 -$25
400 $15,000 $75,000 $90,000 $37.5 $187.5 $225 $50
500 $15,000 $147,500 $162,500 $30 $295 $325 $100
600 $15,000 $225,000 $240,000 $25 $375 $400 $75

7. 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?

C(10,0)= 90 – 0.5Q1Q2 + 0.4Q12 + 0.3Q22

= 90 + (0,4 x 100)
= 130
C(0,10)= 90 – 0.5Q1Q2 + 0.4Q12 + 0.3Q22
= 90 + (0,3 x 100)
= 120
C(10,10) = 90 – 0.5Q1Q2 + 0.4Q12 + 0.3Q22
= 90 – (0.5 x 10 x 10) + (0.4x 100) + (0.3 x 100)
= 200
C(10,0) + C(0,10) = 250 ¿ C(10,10) = 200

It means there’s an economic scope in producing 10 units of product 1

and 10 units of product 2 jointly instead of eparately

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

C(Q1,Q2)=90−0.5Q1Q2 +0.4 Q12 +0.3 Q22

dC
MC 1 = = - 0,5Q 2 + 0,8 Q 1
d Q1
d MC 1
= - 0,5 ¿ 0 , there is a complementarities in producing product 1 & 2
d Q2

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?
 Eric Stevanus - LA28 - 2201756600
As stated above, increasing the output of Q2 decreases the marginal cost of
producing Q1. Therefore, dropping Q2 to zero increases the MC of product 1.

8. Explain the difference between fixed costs, sunk costs, and variable costs. Provide an
example that illustrates that these costs are, in general, different.

Fixed Cost : Fixed costs do not depend on the quantity of the goods the
firm is selling. They are incurred even though the business has not made any
goods at all.
Sunk Cost : Sunk costs are contracts and decisions that are already
vouched and cannot be recovered anymore. Compare to opportunity costs
where one has a decision of giving up something in order to attain another
thing, one has to live with sunk cost because they are expenses that are
permanent.
Variable Cost : Variable costs are costs that depend on the amount or
quantity of the goods that are being produced.
Example Case: Boba Drink Seller
Fixed Cost : The rent of the building he is going to use to run the business,
advertising expense, equipment expenses (blender, cups, utensils), and
others. We may also hire workers needed to operate his business such as a
cashier and a boba maker. This will be included in the business’ salary
expense.
Sunk Cost : If it is not worth it to continue the Boba Drinks in the winter
because people do not want to buy cold drinks in icy weather, we may decide
to shut down the business for the winter season and reopen in the
summer.Fixed cost, which is the rent expense for the building can be
considered a sunk cost because we signed a lease to continue on paying rent
for the whole year.
Variable Cost : The costs included in this category are the supplies expense
needed for the boba drinks (i.e. cups, straws, ingredients). The more sales of
boba drinks, the higher the variable costs being used. In addition, the more
popular and marketable the boba is to the public, the more help the business
needs to create more bobas. Therefore, we has to hire more workers which
increases the salary expenses incurred.

9. 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?

Subtitutes
Q = F(2,3) = min{(4 x 2) ,(8 x 3)}
= min {8 , 24}
 Eric Stevanus - LA28 - 2201756600
=8

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?

Q = 8 units = min {4K,8L}

4K = 8 8L = 8
K=2 & L=1
.Cost min = 2K+ L = ($20 x 2) + (1 x $60)
= $100

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?

.Cost min = 2K + L = ($20 x 2) + (1 x $20)

= $60

10. 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?

Q = F(2,3) = (4 x 2) + (8 x 3)
= 32 units

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?

8
MRTS = Slope of budget or cost line
4
w $ 60
=2 = = =3
r $ 20
MRTS (2) ¿ slope of budget (3) , it means we will use K only
4K = 32 units
K = 8 hours K=8,L=0 Total cost = $160

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?

8
MRTS = Slope of budget or cost line
4
w $ 20
=2 = = =1
r $ 20
MRTS (2) ¿ slope of budget (1) , it means we will use L only
8L = 32 units
L = 4 hours K=0,L=4 Total cost = $80
Eric Stevanus - LA28 - 2201756600