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Gilles Saint-Paul
14.462 Spring 2004 Problem Set 1
Problem set 1

When does it pay to use two technologies at the same time?

Assume that output can be produced using two technologies, labelled by 1
and 2. The production functions are given by

Y1 = K1α L1−α
1

Y2 = K2β L1−β
2

1. Show that if the two technologies are used, the capital labor ratio in
technology 2 must be equal to
� � β−α
α � � 1−α
K2 α 1 − α β−α
k2 = =
L2 β 1−β

� � α−β
β � � 1−β
K1 β 1 − β α−β
k1 = =
L1 α 1−α
Show that this entirely determines factor prices and the allocation of labor
and capital between the two technologies.
2. Show that if α = 1/3, β = 2/3, total capital is K and total labor is L,
then

k2 = 2
k1 = 1/2
2K − L
L2 =
3
4L − 2K
L1 = .
3
3. Between which bounds must the aggregate K/L lie for the two technolo­
gies to be used in equilibrium?
4. Show that if K/L is between these two bounds, then they will actually
be used in equilibrium.
5. Can you explain what is going on in the (K, L) plane?

1
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14.462 Advanced Maroeconomics
Spring 2004

Problem Set 1 Solution

The case α = β is not interesting, so assume β > α. Let r and w be the (shadow)
prices of capital and labor. The cost functions corresponding to the two technologies are
� r �α � w �1−α � �β � �1−β
r w
α 1−α
and β 1−β
, respectively. So using technology one is cheaper if
� α � 1
(1−α)1−α β−α
ω <ω ¯ where ω ≡ wr and ω ¯ ≡ αβ β (1−β) 1−β . If labor is relatively cheap, it is cheaper
to use the labor intensive technology. The capital-labor ratios used as a function of the
α β
relative price of labor are given by κ1 (ω) = 1−α ω and κ2 (ω) = 1−β ω, respectively. We
have k1 = κ1 (¯ ω) and k2 = κ2 (¯ ω). These are the capital-labor ratios employed if both
technologies are used.
Now there are three regions for the capital-labor ratio. If k ∈ [0, k1 ), then κ−1 1 (k) ≤ ω̄
and it is an equilibrium if only technology one is used: if technology one operates with
capital-labor ratio k, this induces a relative price of labor given which it is cheaper to use
technology one. Clearly it is not an equilibrium for both technologies to be used since the
capital-labor ratios k1 and k2 are too large to be consistent with an aggregate ratio of k.
Similarly, if k ∈ [k2 , +∞), then κ−1 2 (k) ≥ ω ¯ and the only equilibrium is that only
technology two is used.
Finally, if k ∈ (k1 , k2 ), then both technologies must be used in equilibrium. If only
technology one is used, then κ−1 1 (k) > ω̄ and technology two is cheaper, a contradiction.
If only technology two is used, then κ−1 2 (k) < ω̄ and technology one is cheaper. There is a
unique equilibrium in which both technologies are used: the two equations k1 L1 +k2 L2 = kL
and L1 + L2 = L have a unique solution and this solution has k1 , L1 , k2 , L2 > 0.
We have determined the allocation of capital and labor for all three regions, which in
turn pins down marginal products and factor prices.
ω κ1 (ω )

κ 2 (ω )

k
k1 k2