ECON2Z03 Chapter 7 Tutorial

1. Acme Container Corporation produces egg cartons that are sold to egg distributors. Acme has estimated this
production function for its egg carton division:
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.
a. Derive the marginal product functions.
b. Determine the optimal capital-labor ratio that Acme should use in the egg carton division.

2. Duane breeds parrots for a living. He has discovered that the production function for parrot chicks (Q) is:
Q = K1/2L1/2
where K is capital (for example nest boxes, cages and the like) and L is parrot food. The marginal products are
as follows:
MPK = 0.5K-1/2L1/2 MPL =0.5K1/2L-1/2
The price of K is $8 and the price of L is $2.

a. Are the two inputs perfect complements, perfect substitutes, or imperfect substitutes?
b. Does this production function exhibit constant, increasing or decreasing returns to scale? Explain.
c. What is the average product of labour?
d. Does labour obey the "law of diminishing returns?" Explain.
e. Suppose that Duane wants 144 parrot chicks, how much K and L should be employed to minimize costs,
and what is the cost of producing 144 parrot chicks?
f. Suppose that Duane is faced with the same problem as in (e) except that he has a fixed amount of K. In fact,
K = 16. How much L should be employed to minimize costs, and what is the total cost?

3. The Longheel Press produces memo pads in its local shop. The company can rent its equipment and hire
workers at competitive rates. Equipment needed for this operation can be rented at $52 per hour, and labor can
be hired at $12 per worker hour. The company has allocated $150,000 for the initial run of memo pads. The
production function using available technology can be expressed as:
Q = 0.25K0.25L0.75
where Q represents memo pads (boxes per hour), K denotes capital input (units per hour), and L denotes labor
input (units of worker time per hour).

a. Construct the isocost equation.

b. Determine the appropriate input mix to get the greatest output for an outlay of $150,000 for a production
run of memo pads. Also, compute the level of output.

4. Two small airlines provide shuttle service between Las Vegas and Reno. The services are alike in every respect
except that Fly Right bought its airplane for $500,000, while Fly by Night rents its plane for $30,000 a year. If Fly
Right were to go out of business, it would be able to rent its plane to another airline for $30,000. Which airline
has the lower costs?
A) Fly by Night
B) Fly Right.
C) Neither, the costs are identical.
D) Neither, Fly by Night has lower costs at small output levels and Fly Right has lower costs at high output
levels.

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5. Trisha believes the production of a dress requires 4 labor hours and 2 machine hours to produce. If Trisha
decides to operate in the short run, she must spend $500 to lease her business space. Also, a labor hour costs $15
and a machine hour costs $35. What is Trisha's cost of production as a function of dresses produced (q)?

6. The total cost (TC) of producing computer software diskettes (Q) is given as: TC = 200 + 5Q. What is the variable
cost?
A) 200
B) 5Q
C) 5
D) 5 + (200/Q)
E) none of the above

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Answer Key
Testname: Econ2Z03 Chapter 7 tutorial

1. a.
K0.4
MPL = .6 25 L-0.4K0.4 = 15
L0.4
L0.6
MPK = .4 25 L0.6K-0.6 = 10
K0.6
b.
MPL
MRTS =
MPK

K0.4
15
L0.4 K0.4 K0.6
MRTS = = 1.5 ·
L0.6 L0.4 L0.6
10
K0.6
K
MRTS = 1.5
L
w
Equate MRTS to .
r
K 10
1.5 =
L 25
K
1.5 = 0.4
L
1.5K = 0.4L; K=0.266L

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Answer Key
Testname: Econ2Z03 Chapter 7 tutorial

2. a.
Imperfect substitutes.

b.
This production function exhibits constant returns to scale.

c.
Q K0.5
APL = =
L L0.5

d.
Yes, labour obeys "the law of diminishing returns" because as L increases, MPL
decreases (L is the deominator).

e.
K
MRTS =
L
w 2
=
r 8
w 2
Equating MRTS to =
r 8
K = 0.25L
Setting it into the function that Q = K1/2L1/2=144
solving for K and L yields K = 72, L = 288, and TC = 1,152.

f.
If K = 16, then Q = 4L.5.
Thus, for Q = 144, L = 1,296 and TC = 2,720.

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Answer Key
Testname: Econ2Z03 Chapter 7 tutorial

3. a.
I = wL + rK
150,000 = 12L + 52K

b.
The appropriate input mix occurs where the

MPL = 0.75 0.25 K0.25L-0.25

MPK = 0.25 0.25 K-0.75L0.75
0.75 0.25 K0.25L-0.25 12
=
0.25 0.25 K-0.75L0.75 52
3K 3 3L L
= K= =
L 13 3 · 13 13
Thus, for each unit of K used, 13 units of labor are used. The total amount of labor used per time period is
150,000 = 12L + 52(L/13)
= 12L + 4L
= 16L
= 9,375
The amount of capital used per time period is
K = L/13 = 9375/13 = 721.15.
The output rate is
Q = 0.25 K0.25 L0.25
= 0.25(721.15)0.25(9375)0.75
= 0.25(5.182)(952.749)
= 1,234.29 boxes per hour.

4. C
5. Since the production of a dress requires spending $60 for labor and $70 for machine hours, Trisha's cost function is:
C(q) = 130q + 500.
6. B