EC202: Intermediate Microeconomics

Semester 1, 2023
Tutorial 5 Solution (Week 6)

Question 1
We said that the production function tells us the maximum output that a firm can produce with its
quantities of inputs. Why do we include the word maximum in this definition?

The production function tells us the maximum volume of output that may be produced given
a combination of inputs. It is possible that the firm might produce less than this amount of
output due to inefficient management of resources. While it is possible to produce many levels
of output with the same level of inputs, some of which are less technically efficient than others,
the production function gives us the upper bound on (the maximum of) the level of output.

Question 2
How does a long-run production function differ from a short-run production function?

A production function represents how inputs are transformed into outputs by a firm. In
particular, a production function describes the maximum output that a firm can produce for
each specified combination of inputs. In the short run, one or more factors of production
cannot be changed, so a short-run production function tells us the maximum output that can
be produced with different amounts of the variable inputs, holding fixed inputs constant. In
the long-run production function, all inputs are variable.

Question 3
What is the difference between a production function and an isoquant?

A production function describes the maximum output that can be achieved with any given
combination of inputs. An isoquant identifies all of the different combinations of inputs that
can be used to produce one particular level of output.

Question 4
Faced with constantly changing conditions, why would a firm ever keep any factors fixed? What
criteria determine whether a factor is fixed or variable?

Whether a factor is fixed or variable depends on the time horizon under consideration: all
factors are fixed in the very short run while all factors are variable in the long run. All fixed
inputs in the short run represent outcomes of previous long-run decisions based on estimates
of what a firm could profitably produce and sell. Some factors are fixed in the short run,
whether the firm likes it or not, simply because it takes time to adjust the levels of those inputs.
For example, a lease on a building may legally bind the firm, some employees may have
contracts that must be upheld, or construction of a new facility may take a year or more. Recall
that the short run is not defined as a specific number of months or years but as that period of
time during which some inputs cannot be changed for reasons such as those given above.
Question 5
A political campaign manager must decide whether to emphasize television advertisements or letters
to potential voters in a reelection campaign. Describe the production function for campaign votes.
How might information about this function (such as the shape of the isoquants) help the campaign
manager to plan strategy?

The output of concern to the campaign manager is the number of votes. The production
function has two inputs, television advertising and letters. The use of these inputs requires
knowledge of the substitution possibilities between them. If the inputs are perfect substitutes
for example, the isoquants are straight lines, and the campaign manager should use only the
less expensive input in this case. If the inputs are not perfect substitutes, the isoquants will have
a convex shape. The campaign manager should then spend the campaign’s budget on the
combination of the two inputs will that maximize the number of votes.

Question 6
Isoquants can be convex, linear, or L-shaped. What does each of these shapes tell you about the
nature of the production function? What does each of these shapes tell you about the MRTS? What
does a MRTS = 4 mean?

Convex isoquants indicate that some units of one input can be substituted for a unit of the other
input while maintaining output at the same level. In this case, the MRTS is diminishing as we
move down along the isoquant. This tells us that it becomes more and more difficult to
substitute one input for the other while keeping output unchanged.

Linear isoquants imply that the slope, or the MRTS, is constant. This means that the same
number of units of one input can always be exchanged for a unit of the other input holding
output constant. The inputs are perfect substitutes in this case.

L-shaped isoquants imply that the inputs are perfect complements, and the firm is producing
under a fixed proportions type of technology. In this case the firm cannot give up one input in
exchange for the other and still maintain the same level of output. For example, the firm may
require exactly 4 units of capital for each unit of labour , in which case one input cannot be
substituted for the other.

If the MRTS is 4 then one input can be reduced by 4 units as the other is increased by one
unit, and output will remain the same.
Question 7
Explain the term “marginal rate of technical substitution.” Explain why the marginal rate of
technical substitution is likely to diminish as more and more labour is substituted for capital.
MRTS is the amount by which the quantity of one input can be reduced when the other input
is increased by one unit, while maintaining the same level of output.
As more and more labour is substituted for capital, it becomes increasingly difficult for
labour to perform the jobs previously done by capital. Therefore, more units of labour will
be required to replace each unit of capital, and the MRTS will diminish. For example, think
of employing more and more farm labour while reducing the number of tractor hours used.

Question 8
What is the elasticity of substitution? What does it tell us?

The elasticity of substitution measures how the marginal rate of technical substitution of
labour for capital changes as we move along an isoquant. Essentially this value tells us the
level of substitutability between capital and labour , i.e., how easily the firm can substitute
capital for labour to maintain the same level of total output.

Question 9
Suppose the production function is given by the following equation (where a and b are positive
constants): Q = aL + bK. What is the marginal rate of technical substitution of labour for capital
(MRTSL,K) at any point along an isoquant?

For this production function MPL  a and MPK  b . The MRTSL,K is therefore

MPL a
MRTS  

L,K
MPK b

Question 10
Could the isoquants corresponding to two different levels of output ever cross?

No, as with indifference curves, isoquants can never cross. For example, suppose we draw
isoquants for two levels of output Q1 and Q2 with Q2  Q1 . In addition, suppose that these

isoquants crossed at some point A as in the following diagram.

 Capital

Q2
Q1

Labour

Because A and B are on Q2, both achieve the same level of output. Since A and C are on Q1,
both achieve the same level of output. This would imply that B and C achieve the same level
of output. However, this is not possible since point C contains more of both inputs which
would achieve a higher level of output. Therefore, isoquants cannot cross.

Question 11
Suppose the production of electricity requires just two inputs, capital and labour , and that the
production function is Cobb–Douglas. Now consider the isoquants corresponding to three different
levels of output: Q = 100,000 kilowatt-hours, Q = 200,000 kilowatt-hours, and Q = 400,000
kilowatt-hours. Sketch these isoquants under three different assumptions about returns to scale:
constant returns to scale, increasing returns to scale, and decreasing returns to scale.

Decreasing Returns to Scale

1,000

750
Capital

Q=400,000
500

250
Q=200,000
Q=100,000
250 500 750 1,000

Labo
ur

With decreasing returns to scale the firm needs to more than double inputs to double
output. Equivalently, doubling inputs less than doubles output.
 Increasing Returns to Scale

Q=100,000
1,000
Q=200,000
750 Q=400,000
Capital

500

250

250 500 750 1,000

Labo
ur

With increasing returns to scale the firm needs to less than double the inputs to
double the output. Equivalently, doubling inputs more than doubles output.

Constant Returns to Scale

1,000

750
Capital

500
Q=400,000
250
Q=200,000
Q=100,000
- 250 500 750 1,000

Labo
ur

With constant returns to scale the firms needs to double inputs to double output.
Question 12
Let B be the number of bicycles produced from F bicycle frames and T tires. Every bicycle needs
exactly two tires and one frame.

a) Draw the isoquants for bicycle production.

This isoquants for this situation will be L-shaped as in the following diagram
Tires

6 Q=3

4 Q=2

2 Q=1

Frames
1 2 3

These L-shaped isoquants imply that once you have the correct combination
of inputs, say 2 frames and 4 tires, additional units of one resource without
more units of the other resource will not result in any additional output.

b) Write a mathematical expression for the production function for bicycles.

Mathematically this production function can be written

1
Q  min(F, T )
2
where F and T represent the number of frames and tires.
Question 13
The marginal product of labour in the production of computer chips is 50 chips per hour. The
marginal rate of technical substitution of hours of labour for hours of machine capital is 1/4. What is
the marginal product of capital?

The marginal rate of technical substitution is defined at the ratio of the two marginal products.
Here, we are given the marginal product of labour and the marginal rate of technical
substitution. To determine the marginal product of capital, substitute the given values for the
marginal product of labour and the marginal rate of technical substitution into the following
formula:

𝑴𝑷𝑳 𝟓𝟎 𝟏
= 𝑴𝑹𝑻𝑺 ; 𝒐𝒓 =
𝑴𝑷𝑲 𝑴𝑷𝑲 𝟒
.
Therefore, MPK = 200 computer chips per hour.

Question 14
Do the following functions exhibit increasing, constant, or decreasing returns to scale? What happens
to the marginal product of each individual factor as that factor is increased and the other factor held
constant?

a) q = 3L + 2K

This function exhibits constant returns to scale. For example, if L is 2 and K is 2 then q is
10. If L is 4 and K is 4 then q is 20. When the inputs are doubled, output will double. Each
marginal product is constant for this production function. When L increases by 1, q will
increase by 3. When K increases by 1, q will increase by 2.

b) q 3LK2

This function exhibits increasing returns to scale. For example, if L is 2 and K is 2,then q
is 24. If L is 4 and K is 4 then q is 192. When the inputs are doubled, output more than
doubles. Notice also that if we increase each input by the same factor λ then we get the
following:

𝒒′ = 𝟑 (𝝀𝑳)(𝝀𝑲)𝟐 = 𝝀𝟑 𝟑𝑳𝑲𝟐 = 𝝀𝟑 𝒒

Since λ is raised to a power greater than 1, we have increasing returns to scale.

The marginal product of labour is constant and the marginal product of capital is
increasing. For any given value of K, when L is increased by 1 unit, q will go up by 3K2
units, which is a constant number. Using calculus, the marginal product of capital is MPK
= 6LK. As K increases, MPK increases. If you do not know calculus, you can fix the value
of L, choose a starting value for K, and find q. Now increase K by 1 unit and find the new
q. Do this a few more times and you can calculate marginal product.
c) 𝒒 = 𝑳𝟎.𝟓 𝑲𝟎.𝟓

This function exhibits constant returns to scale. For example, if L is 2 and K is 2 then q is
2. If L is 4 and K is 4 then q is 4. When the inputs are doubled, output will exactly double.
Notice also that if we increase each input by the same factor, λ , then we get the following:
𝟏 𝟏
𝒒′ = (𝝀𝑳)𝟐 (𝝀𝒌)𝟐 = 𝝀𝑳𝟎.𝟓 𝑲𝟎.𝟓 = 𝝀𝒒

Since λ is raised to the power 1, there are constant returns to scale. The marginal product
of labour is decreasing and the marginal product of capital is decreasing. Using calculus,
the marginal product of capital is
𝑳𝟎.𝟓
𝑴𝑷𝑲 = 𝟐𝑲𝟎.𝟓
For any given value of L, as K increases, MPK will decrease. If you do not know calculus
then you can fix the value of L, choose a starting value for K, and find q. Let L=4 for
example. If K is 4 then q is 4, if K is 5 then q is 4.47, and if K is 6 then q is 4.90. The marginal
product of the 5th unit of K is 4.47−4 = 0.47, and the marginal product of the 6th unit of K
is 4.90−4.47 = 0.43. Hence we have diminishing marginal product of capital. You can do
the same thing for the marginal product of labour .

d) 𝑞 = 4𝐿0.5 + 4𝐾

This function exhibits decreasing returns to scale. For example, if L is 2 and K is 2 then q
is 13.66. If L is 4 and K is 4 then q is 24. When the inputs are doubled, output increases by
less than double.

The marginal product of labour is decreasing and the marginal product of capital is
constant. For any given value of L, when K is increased by 1 unit, q goes up by 4 units,
which is a constant number. To see that the marginal product of labour is decreasing, fix
K=1 and choose values for L. If L=1 then q=8, if L=2 then q=9.66, and if L=3 then q=10.93.
The marginal product of the second unit of labour is 9.66–8=1.66, and the marginal
product of the third unit of labour is 10.93–9.66=1.27. Marginal product of labour is
diminishing.

***The End***