Mini Quiz 2

ISHISE, Hirokazu

Graduate Introductory Macroeconomics: Mini Quiz 2

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Student ID:

Increasing returns to scale

Suppose that for an operation, a firm needs to employ f > 0 units of labor adding to labor
proportional to output. The firm faces a downward sloping demand curve. A firm chooses
p(j), y(j) and l(j), for taking z(j), w, p, y and f as given.
max

p(j)y(j) wl(j) wf

{p(j),y(j),l(j)}

s.t.

y(j) = z(j)l(j)
(
)
p
y(j) =
y.
p(j)

Note that the productivity z(j) diers across firms.

Question 1 (2 points)
Set-up a Lagrangian of the firms optimization problem.

((
L = p(j)y(j) wl(j) wf + (j)

p
p(j)

)
y y(j) + (j) (z(j)l(j) y(j)) .

(1)

Question 1 (3 points)
Derive first order conditions of the firms optimization problem.

FOCs are
0 = y(j) (j)p p(j)1 y,
0 = p(j) (j) (j),
0 = w + (j)z(j).

Graduate Introductory Macroeconomics

(2)
(3)
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Summer 2014

Mini Quiz 2

ISHISE, Hirokazu

Question 3 (2 point)
Derive the expression of p(j) (as a function of exogenous variables and parameters).

p(j) =

w
.
1 z(j)

(5)

Question 4 (2 points)
Derive the expression of l(j).

l(j) = ( 1) p yw z(j)1

(6)

Question 5 (1 point)
Derive the expression of the profits of the firm.

z(j)l(j) wl(j) wf
1 z(j)
1
=
wl(j) wf
1
1
=
w ( 1) p yw z(j)1 wf
1
= ( 1)1 p yw+1 z(j)1 wf

p(j)y(j) wl(j) wf =

(7)

Question 6 (2 points, bonus, dicult)

In this model, some firms have high z(j), while others have low productivity. If a firms
productivity is very low, the firm would earn the negative profits. If a firms productivity is
high, the firm earns positive profits. There should be a cut-o productivity, z(j) = z. If a firm
has higher productivity than this cut-o, the firm operates. If a firm has lower productivity
2

Graduate Introductory Macroeconomics

Summer 2014

Mini Quiz 2

ISHISE, Hirokazu

than this cut-o, the firm does not operate. Using the zero-profits condition, determine the
cut-o productivity z.

A firm earns zero-profits if the firms productivity satisfies the zero-profits condition:
0 = ( 1)1 p yw+1 z(j)1 wf.

(8)

The cut-o productivity z is this z(j). Hence,

0 = ( 1)1 p yw+1 z1 wf,

(9)

or

1
z =
1

(
( ) 1
) 1
w
f 1
.
p
y

Graduate Introductory Macroeconomics

(10)

Summer 2014