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HW 4 Key - Problem Set 4 Solution Key Suppose in some...

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Unformatted text preview: Problem Set 4 Solution Key Suppose in some market that a typical firm’s production function of two inputs, labor and capital, given by Q = Ll/ZK 1/2. The wage rate is represented by w and the rent rate is represented by r. a- Identify the type ofreturns to scale this production function represents? lfthe firm hires L units oflabor and hires K units ofcapital, then he can produce at most L l/2K ”2 scale up all inputs by X, A > 1. The firm now produces (101/2 (2101/2 = )t (Ll/ZKl/Z) units of output. Since, the output is units ofoutput. Let us also scaled up by it, we can conclude that this production function represents constant returns to scale. For parts b , c: assume that capital is fixed in the short-run and it is equal to . b— Derive the short—run demand for labor. When the capital level is fixed, say 7?, the production function becomes Q = L “Fl/2. Ifwe solve for L, we can derive 2 2 the short—run demand for labor: L = ($7) = %2. So, the short—run demand for labor is LSR (Q) = 9?. c— Derive the short-run total production cost. The short—run total production cost is 2 _ CSR(Q)=wX%+rXK. For parts d, e,f,g: assume that all inputs are variable. d, e- Derive the long-run demand for labor and capital. Q : Ll/ZKl/Z MPI _ itfl/ZKVZ _ g MPK _ %LI/2K—l/Z _ L We know that at an interior optimum: fill; : 3 Hence, ,5 = 'f => K = rflL. We also know that the production function holds. That is, Q = L l/2K1/2. Now, we must solve these two equations: Q = LWKW : Q = L”2 (ml/2 = L( )”2 2 L = Q (LY/2 I' U.) % Then, the capital level becomes K = % (Q (5)1/2) = Q (3)1/2. I‘ Therefore, the long-run demand for labor and the long—run demand for capital are L” (Q) = Q (L)”2 and K” (Q) = Q g)”, respectively. U.) f- Derive the long-run total production cost. 1 2 1/2 C”(Q>=wx Q(&)/ +rx Q(%) 2 c” (Q) = 2Q (wrW2 g- Does this cost structure exhibit scale economies? Explain. First, we must calculate average cost. ACLR (Q) = 2 (wr)'/2. As quantity increases average cost does not change, so there are constant returns to scale. ...
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