Problem Set 5 (Chapter 7) Due: 04/02/2019

Problems: 1.2, 1.4, 2.4, 2.6, 2.8, 2.11, 2.13, 3.1, 3.3 – 3.6, 3.12 – 3.14.

1.2 You have a ticket to a concert by one of your favorite groups, the Hives, which you bought for $100
and that you cannot resell. However, you can buy a ticket for $30 to attend a talk by Steven Colbert,
which is at the same time as the concert. You are willing to pay up to $90 to hear Colbert. Given that you
incur no other costs from attending either event, what is your opportunity cost of attending the Hives
concert? (Hint: See Solved Problem 7.1.)

1.4 A firm purchased copper pipes a few years ago at $10 per pipe and stored them, using them only as
the need arose. The firm could sell its remaining pipes in the market at the current price of $9. What is
the opportunity cost of each pipe and what is the sunk cost?

2.4 In 1796, Gottfried Christoph Härtel, a German music publisher, calculated the cost of printing music
using an engraved plate technology and used these estimated cost functions to make production
decisions. Härtel figured that the fixed cost of printing a musical page—the cost of engraving the plates
—was 900 pfennings. The marginal cost of each additional copy of the page was 5 pfennings (Scherer,
2001).

a. Graph the total cost, average total cost, average variable cost, and marginal cost functions.

b. Is the cost of only one music publisher printing a given composition lower than if several firms print
it? Why?

c. Härtel used his data to do the following type of analysis. Suppose he expected to sell exactly 300
copies of a composition at 15 pfennings per page. What was the greatest amount the publisher would
be willing to pay the composer per page of the composition?

2.6 Give the formulas for and plot AFC, MC, AVC, and AC if the cost function is

a. C=10+10q.

b. C=10+q2.

c. C=10+10q−4q2+q3.

2.8 A firm’s cost curve is C=F+10q−bq2+q3, where b>0.

a. For what values of b are cost, average cost, and average variable cost positive? (From now on, assume
that all these measures of cost are positive at every output level.)

b. What is the shape of the AC curve? At what output level does the firm minimize its AC?

c. At what output levels does the MC curve cross the AC and the AVC curves?

2.11 A Chinese high technology manufacturing firm has a production function of q=10 L0.28 K 0.64 (based
on Zhang et al., 2012). It faces factor prices of w=10 and r=20. What are its short-run marginal cost and
average variable cost curves? (Hint: See Appendix 7B.)

2.13 In the Application “A Beer Manufacturer’s Short-Run Cost Curves,” the short-run variable cost
function for Japanese beer is VC=0.55q1.67. If the fixed cost is 600 and the firm produces 550 units,
 Problem Set 5 (Chapter 7) Due: 04/02/2019

determine the C, VC, MC, AFC, and AVC. What happens to these costs if the firm increases its output to
600?

3.1 Initially a firm’s wage is w=10 and its rental cost of capital is r=10. After its wage rate doubles, how
do its isocost lines change?

3.3 A bottling company uses two inputs to produce bottles of the soft drink Sludge: bottling machines (K)
and workers (L). The isoquants have the usual smooth shape. The machine costs $1,000 per day to run.
The workers earn $200 per day. At the current level of production, the marginal product of the machine
is an additional 200 bottles per day, and the marginal product of labor is 50 more bottles per day. Is this
firm producing at minimum cost? If it is minimizing cost, explain why. If it is not minimizing cost, explain
how the firm should change the ratio of inputs it uses to lower its cost. (Hint: Examine the conditions for
minimizing cost: Equations 7.5 or 7.8. See Solved Problem 7.3.)

3.4 Use the tangency rule to determine the cost-minimizing bundles of labor and capital for a Japanese
synthetic rubber firm’s production functionq=L0.5 K 0.5 (Flath, 2011) where w=10 and r=10. How does
your answer change if w=20 and r=10? (Hint: See Solved Problem 7.3.)

3.5 A U.S. electronics firm is considering moving its production abroad. Its production function is
0.5
q=L0.5 K 0.5 (based on Hsieh, 1995), so its MPL= ¿ 1/2(K ¿ ¿ 0.5 ¿ L )¿ and its MPK=
¿ 1/2(L ¿ ¿ 0.5/ K 0.5 )¿ (as Appendix 6C shows). The U.S. factor prices are w=r=10. In Mexico, the wage is
half that in the United States but the firm faces the same cost of capital: w*=5 and r*=r=10. What are L
and K, and what is the cost of producing q=100 units in both countries? (Hint: See Solved Problem 7.3.)

3.6 A U.S. apparel manufacturer is considering moving its production abroad. Its production function is
q=L0.7 K 0.3 (based on Hsieh, 1995), so its MPL=0.7q/L and its MPK=0.3q/K. In the United States, w=7
and r=3. At its Asian plant, the firm will pay a 10% lower wage and a 10% higher cost of capital: w=7/1.1
and r=3×1.1. What are L and K, and what is the cost of producing q=100 units in both countries? What
would the cost of production be in Asia if the firm had to use the same factor quantities as in the United
States? (Hint: See Solved Problem 7.4.)

3.12 What is the long-run cost function if the production function is q=L+K?

3.13 Suppose that your firm’s production function has constant returns to scale. What is the expansion
path? (Hint: See Solved Problem 7.5.)

3.14 A U.S. glass manufacturer’s production function isq=10 L0.5 K 0.5 (based on Hsieh, 1995). Its
marginal product functions are MPL=5(K ¿ ¿ 0.5 ¿ L0.5 )¿=0.5q/L and MPK=5 ¿ ¿=0.5q/K. Suppose that its
wage, w, is $1 per hour and the rental cost of capital, r, is $4.

a. Draw an accurate figure showing how the glass firm minimizes its cost of production. (Hint: See Solved
Problem 7.4.)

b. What is the equation of the (long-run) expansion path for the glass firm? Illustrate this path in a
graph.

c. Derive the long-run total cost curve equation as a function of q.

 Problem Set 5 (Chapter 7) Due: 04/02/2019

Answers:

1.2 The opportunity cost of a resource is the value of the best alternative use of that resource. In this
instance, the opportunity cost of attending the Hives concert is the net value of hearing Colbert.
Because the value of hearing Colbert is $90 but it only costs $30 for admission to his talk, the net
opportunity cost of attending the Hives concert is $60.
1.4 The opportunity cost of a resource is the value of the next best alternative use of that resource.
Thus, the opportunity cost of the pipe is $9 because that is the amount that it could otherwise be
sold for. A sunk cost is a past expenditure that cannot be recovered. The pipe’s sunk cost is $1
because this amount cannot be recovered.
2.4
TC = 900 + 5q,
AFC = 900/q,
AVC = 5,
ATC = 900/q + 5,
MC = 5.
a. The graphs are produced in the audio-PowerPoint presentation.
b. Note that ATC becomes smaller as the production increases, so there is an advantage to having
only one big music publisher. This is because the fixed cost is spread over a larger production,
although the MC is constant and equal to 5.
c. Revenue – publishing cost = 300  15 – (900 + 5  300) = 4,500 – 2,400 = 2,100. The
publisher is willing to pay up to 2,100 pfennigs to the composer.
2.6
a. AFC = 10/q.
MC = 10.
AVC = 10.
AC = 10/q + 10.

b. AFC = 10/q.
MC = 2q.
AVC = q.
 Problem Set 5 (Chapter 7) Due: 04/02/2019

AC = 10/q + q

c. AFC = 10/q.
MC = 10 + 8q + 3q2.
AVC = 10 + 4q + q2.
AC = 10/q + 10 + 4q + q2.

2.8 a. Variable cost is

VC(q) = 10q – bq2 + q3.

Average variable cost is

AVC(q) = 10 – bq + q2.

For this to be positive,

10 – bq + q2 > 0

10 + q2 > bq

b < 10/q + q,
b. The average cost curve is U-shaped. AC is minimized at dAC/dq  Fq2  b  2q  0.
c. MC crosses AC when the functions are equal. MC  AC where 10  2bq  3q2  F/q  10  bq 
q2. MC  AVC where 10  2bq  3q2  10  bq  q2, or where q = b/2.
d. AVC is minimized where dAVC/dq  0.
 Problem Set 5 (Chapter 7) Due: 04/02/2019

dAVC/dq  – b  2q  0
or b  2q
MC  AVC
where
10  2bq  3q2  10  bq  q2.
Substituting 2q for b on both sides yields
10  q2  10 q2
2.11 Let K be fixed in the short run.
First, use the production function to derive variable cost, where K is fixed at K. Solving for L as a
function of output (and capital, which is fixed):
q
L0.28 
10 K 0.64
3.57
 q 
L  0.64 
 10 K  .
If the only variable input is labor and the wage is w, then variable cost as a function of w and L is
VC = wL. Variable cost therefore equals
3.57
 q 
VC  w  0.64 
 10 K 
3.57
 q 
VC  10  0.64 
 10 K  .
Average variable cost as a function of output, AVC, is variable cost, VC, divided by q:
3.57
 q 
AVC  10  0.64 
/q
 10 K 
3.57
 1 
AVC  10  0.64 
(q ) 2.57
 10 K  .
To obtain marginal cost as a function of output, MC, differentiate variable cost, VC, with respect
to output:
3.57
 1 
MC  35.7  0.64 
( q )2.57
 10 K  .

2.13 A variable cost (VC) is a cost that changes as the quantity of output changes. For example, if
output is 550, then VC = 37.71.
A firm’s cost is the sum of a firm’s variable cost (VC) and fixed cost (F):
C = VC + F
C = 37.71 + 600 = 637.71.
A firm’s marginal cost (MC) is the amount by which a firm’s cost changes if the firm produces
 Problem Set 5 (Chapter 7) Due: 04/02/2019

one more unit of output. The marginal cost is

VC
MC = q
MC = 0.3685q–0.33
MC = 0.05.
The average fixed cost (AFC) is the fixed cost divided by the units of output produced: 600/550 =
1.09. Average variable cost (AVC) or variable cost per unit of output is the variable cost divided
by the units of output produced: 37.71/550 = 0.07.
Similarly, if output increases to 600, then VC = 39.97, C = 639.97, MC = 0.04, AFC = 1.00, and
AVC = 0.07.

3.1 An isocost line shows all the combinations of inputs that require the same total expenditure or
w

cost. The slope of an isocost line is r . When w = 10 and r = 10, this slope is –1.0. When the
wage doubles, it becomes w = 20 and the slope of the isocost line becomes –2.0. That is, when the
wage doubles, the isocost line becomes steeper (and its slope increases in absolute value).

3.3 According to Equation 7.7, if the firm were minimizing its cost, the extra output it gets from the
MPL /w  200
50
 0.25,
last dollar spent on labor, should equal the extra output it derives from the
MPK /r  1000
200
 0.2.
last dollar spent on capital, Thus, the firm is not minimizing its costs. It
would do better if it used relatively less capital and more labor, from which it gets more extra
output from the last dollar spent.
3.4 The tangency rules states that the firm chooses the input bundle where the relevant isoquant is
tangent to an isocost line to produce a given level of output at the lowest cost. The slope of a
Cobb-Douglas isoquant is the marginal rate of technical substitution (MRTS):
K

MRTS= L .
w

We know that cost is minimized if the MRTS equals the slope of the isocost, r :
K w
 
L r .
Rearranging this expression, we find that at the cost-minimizing bundle,
w
L
K= r
10
L
K = 10
K = L.
If w = 20 and r = 10, then
20
L
K = 10
 Problem Set 5 (Chapter 7) Due: 04/02/2019

K = 2L.
3.5 For this Cobb-Douglas function, MRTS = (K/L).
The optimum combination of K and L for the United States is found by solving the following
system of equation:
(K/L) = (10/10) and 100 = K0.5L0.5  K* = L* = 100.
Thus
TC = $2000.
The optimum combination of K and L for Mexico is found by solving the following system of
equation:
(K/L) = (5/10) and 100 = K0.5L0.5  K* = 70.7, L* = 141.4.
Thus
TC = $1414.2.
3.6 The firm chooses its optimal labor/capital ratio using Equation 7.7: MPL/w = MPK/r. That is, 0.5q/
(wL) = 0.5q/(rK), or L/K = r/w. Thus, in the United States where w = r = 10, the optimal L/K = 1,
or L = K. Making use of L = K, the U.S. plant produces where q = 100 = L0.5K0.5 = K 0.5K 0.5 = K.
Therefore, K = 100 = L. The cost is C = wL = rK = (10  100) = (10  100) = 2000. At its Asian
plant, the optimal input ratio is L*/K* = r*/w* = 11/(10/1.1) = 1.21. That is, L* = 1.21K*, so
therefore, K* = 100/1.1 and L* = 110. The cost is C* = [(10/1.1)  110]  [11  (100/1.1)] =
2000. That is, the firm will use a different factor ratio in Asia, but the cost will be the same. If the
firm could not substitute toward the less expensive input, its cost in Asia would be C** =
[(10/1.1)  100] = [11  100] = 2009.09.
3.12 Let w be the cost of a unit of L and r be the cost of a unit of K. Because the two inputs are perfect
substitutes in the production process, the firm uses only the less expensive of the two inputs.
Therefore, the long-run cost function is C(q) = wq if w  r; otherwise, it is C(q) = rq.
3.13 If there are constant returns to scale, the long-run expansion path will be a straight line, indicating
a constant capital–labor ratio. As the firm expands under constant returns, proportional increases
in both inputs yield the same proportional increase in output. In other words, they increase by
equal amounts. For example, the doubling of both inputs doubles output.
3.14
a. See the following figure.
b. MPL/MPK = (1/2q/L)/(1/2q/K) = K/L = w/r = ¼; thus K = L/4.
c. c = wL + rK = L + 4L/4 = 2L;
 Problem Set 5 (Chapter 7) Due: 04/02/2019

q = 10(LK)1/2 = 10[(1/4)L2]1/2= 5L = > L = q/5;

c = 2L = 2q/5 = 0.4q