EC207_mt2ans - The Colorado College Department of Economics...

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1 The Colorado College Department of Economics and Business Block 7 Econ 207 Midterm 2 answers. 1. (a) Here MP L = 20; MP K = 10 3 1 ; 10 20 = = r w MP MP K L So r w MP MP K L r MP w MP K L By spending $1 on labor a firm gets more output compared to that from capital. So the firm is not employing the optimal combination of L, K. It should hire more labor. (In this case only labor as RTS is constant). (b) (i) 5 . 0 5 . 0 K L q = 5 . 0 5 . 0 5 . 0 ) ( 5 . 0 5 . 0 L K L K L q MP L = = = - 5 . 0 5 . 0 5 . 0 ) ( 5 . 0 5 . 0 K L K L K q MP K = = = - L K MP MP MRTS K L = = As more labor is used, K/L falls, so marginal productivity of labor falls. Similarly, as more capital is used, L/K falls, marginal productivity of capital falls. (ii) At all points on the expansion r w MRTS = Here L K MRTS = So equation of expansion path is L r w K ) ( = (c) (i) 16 4 4 16 2 5 . 0 5 . 0 5 . 0 5 . 0 q L L q L q L q = = = = 240 16 5 ) 16 ( 15 16 5 . . 2
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EC207_mt2ans - The Colorado College Department of Economics...

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