John Riley 28 July 2019
Exercises and answers
Exercise 1: Price taking firm1
The total cost of producing q units is C(q) 6q2 q3 . The price of output is p 0
dC
(a) Write down the derivative of the cost function (q) (the marginal cost function).
dq
(b) Explain why the profit maximizing output is strictly positive.
HINT: Compare MR(q) and MC(q) at q=0.
(c) Show that the profit maximizing output is 2 if p 36 .
HINT: Show that marginal profit can be written as a quadratic expression with two roots that
are integers. Use this to examine whether marginal profit is positive or negative for all q 2
Exercise 2: Supply curve of a price taking firm
The total cost of producing q units is C(q) 10q 2q2 .
(a) If the price is (i) 20, (ii) 8 what is the profit maximizing output.
(b) What is the firm’s supply curve (maximized output expressed as a function of the output
price)?
3. Profit Maximization
A monopoly with output q has a profit of (q) 864q 252q2 28q3 q4 .
d
(a) Show that marginal profit is 4(q 3)(q 6)(q 12) .
dq
(b) Show that there is one strict local minimum and that there are two strict local maxima.
(c) Solve for the maximizing output.
1
Answers can be found on page 3. But no peeking till you have worked on the exercises!
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John Riley 28 July 2019
4: Production and Cost
1 1
With z1 units of input 1 and z2 units of input 2, a firm can produce an output of q z12 z2 2 . The
input price vector is r (r1, r2 ) . The firm’s objective is to minimize the cost of producing q units
of output.
(a) Show that the firm’s cost as a function of input 1 can be written as follows:
r2q2
C r1z1
z1
(b) Obtain expressions for the first and second derivatives of this function and hence show that
r 1
the cost minimizing demand for input 1 is z1 ( 2 ) 2 q .
r1
(c) Obtain an expression for the demand for input 2 and hence solve for the minimized total
cost.
(d) What is the (i) average cost (ii) marginal cost of production of this firm?
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John Riley 28 July 2019
Answers
Exercise 1: Price taking firm
The total cost of producing q units is C(q) 6q2 q3 . The price of output is p 0
dC
(a) MC (q) 12q 3q2
dq
(b) Marginal cost is zero at q 0 and increases with q. Since MR = p > 0. Marginal profit is
strictly positive at q 0 .
d
(c) If p 36, then 36 12q 3q2 3(12 4q q2 ) 3(6 q)(2 q) .
dq
Note that marginal profit is strictly positive if q is in the interval [0,2) and strictly negative for
q 2 . Thus profit is maximized at q 2 .
Exercise 2: Supply curve of a price taking firm
The total cost of producing q units is C(q) 10q 2q2 .
d
(a) Marginal profit is p 10 4q . This is strictly decreasing.
dq
(i) If p 10 marginal profit is positive for low output level and negative thereafter. Thus profit
is maximized at q 14 ( p 10) .
(ii) If p 10 , marginal profit is negative at all output levels and so the profit-maximizing
output is zero.
0, p 10
(b) q( p) 1
4 ( p 10), p 10
3. Profit Maximization
(a) A monopoly with output q has a profit of (q) 864q 252q2 28q3 q4 .
d
864 504q 84q2 4q3
dq
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John Riley 28 July 2019
4(q3 21q2 126q 216)
4(q 3)(q 6)(q 12) .
(b) Thus marginal profit changes sign at q 3,6,12 . It is strictly positive on [0,3) and (6,12) . It
is strictly negative on (3,6) and (12, ) . Thus there are strict local maxima at q 3 and
q 12 . There is a strict local minimum at q 6 .
(c) The graph of the function (from an EXCEL spreadsheet) is depicted below.
Substituting into the expression for profit, profit is maximized at q 12 .
4: Production and Cost
1 1
To produce q units of output, the input vector z must satisfy q z12 z2 2 , i.e. q2 z1z2 . Then
q2
z2 . Total cost is therefore
z1
r2q2
C r1z1 r2 z2 r1z1
z1
r2q2 2r2q2
C(z1) r1 and C( z1 ) 0.
z12 z13
C(z1) thus has a critical point where z1 satisfies
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John Riley 28 July 2019
r2q2
C(z1) r1 0.
z12
Solving,
r
z1 ( 2 )1/2 q .
r1
Since C(z) is everywhere increasing, the critical point is the cost minimizing level of input 1.
By a symmetrical argument (or by noting that z1z2 q2 ),
r
z2 ( 1 )1/2 q
r2
Then minimized total cost is
C r1z1 r2 z2 2(rr 1/2
1 2) q
C
AC 2(rr
1 2)
1/2
, MC C(q) 2(rr
1 2)
1/2
q
