MG207 Managerial Economics

London School of Economics

Producer Theory Assignment 1

In the lecture, we had an input bundle given by (x1 , x2 , ..., xn ). In this assignment,
we will call our inputs L and K, i.e. labor and capital, and assume that these are the
only inputs to produce output (by convention we put L on x-axis and K on y-axis in a
2 dimensional inputs space).

Question 1
Find and sketch isoquants corresponding to the following production functions:

Part a
The inputs are perfect complements: f (L, K) = min(3L, K).

Answer: The isoquants are the combinations of factors, L and K that produce the same
amount of quantity with a given production function. When the production function is
f (L, K) = min(3L, K), the isoquants are given by min(3L, K) = y, and are L shaped
with the kinks along the line K = 3L. To see why we have a L shaped isoquant, consider
the isoquant of 12. What are the combinations of (L, K) that lead to output of 12?
Examples include (4, 12), (6, 12), etc or (4,9), (4, 10), etc. As we can see in this example
the kink is at L = 4 and L = 12.
K
K = 3L

12

L
1 2 3 4

Figure 1: Question 1 part a

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Part b
The inputs are perfect substitutes: f (L, K) = L + K.

Answer: The isoquant for an output level y will be represented by the function L + K =
y. This is just a line with intercept y and slope of −1 if plotted on a L-K graph.

Figure 2: Question 1 part b

Part c
The inputs are substitutable: f (L, K) = L0.5 K 0.5 .

Answer: The isoquant for an output level y will be represented by the function L0.5 K 0.5 =
y. Rearranging for K we will have K = y 2 /L. This is just a convex function and decreas-
ing function that does not touch any of the axes but asymptotes to them as L tends to
1 or 0. These are the typical Cobb-Douglas isoquants.

Figure 3: Question 1 part c

Question 2
Classify the following functions as having increasing, decreasing, or constant returns to
scale. Does capital exhibit diminishing marginal product in each case? Explain your

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answers.

Part a
f (L, K) = L + K

Answer: Since we have f (tL, tK) = tL + tK = t(L + K) = tf (L, K) where t > 1,

this production function is constant return to scale. In general, the perfect substitute
production functions, f (L, K) = aL + bK (where a, b > 0), all have constant return to
scale, as f (tL, tK) = taL + tbK = t(aL + bK) = tf (L, K) where t > 1.
The marginal product of capital is ∂f ∂K
(L,K)
= 1. Therefore, the marginal product of
capital is constant.

Part b
f (L, K) = min(K, L)

Answer: Since we have f (tL, tK) = min(tL, tK) = tf (L, K) where t > 1, this pro-
duction function exhibits constant returns to scale. In general, the perfect complements
production functions, f (L, K) = min(aL, bK) (where a, b > 0), all have constant return
to scale, as f (tL, tK) = min(taL, tbK) = t min(aL, bK) = tf (L, K) where t > 1.
To calculate the marginal product of capital, we rewrite the production function as
the following: 
L L6K
f (L, K) =
K L>K
The marginal production of capital is thus

∂f (L, K) 0 L6K
M PK = =
∂K 1 L>K

which is a step function and is constant.

Part c
f (L, K) = L0.5 K 0.5

Answer: Since we have f (tL, tK) = (tL)0.5 (tK)0.5 = t0.5+0.5 L0.5 K 0.5 = tf (L, K) where
t > 1, this production function exhibits constant return to scale.
The marginal product of capital is M PK = ∂f ∂K(L,K)
= 0.5L0.5 K −0.5 . Obviously, M PK
is both a function of K and L. Now we take the first order derivative w.r.t M PK (i.e.
the second order derivative of f (L, K) w.r.t. K),

∂ 2 f (L, K)
M PK = = −0.25L0.5 K −1.5 < 0
∂K 2
Therefore, the marginal product of capital is diminishing.

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Part d
f (L, K) = LK 2

Answer: Since we have f (tL, tK) = (tL)(tK)2 = t1+2 LK 2 = t3 f (L, K) where t > 1,
this production function exhibits increasing return to scale.
The marginal product of capital is M PK = ∂f ∂K
(L,K)
= 2LK. Obviously, M PK is both
a function of K and L. Now we take the first order derivative w.r.t M PK (i.e. the second
order derivative of f (L, K) w.r.t. K),

∂ 2 f (L, K)
M PK = = 2L > 0
∂K 2
Therefore, the marginal product of capital is increasing in K.

Question 3
Suppose a firm has Cobb-Douglas production function: f (L, K) = Lα K β and suppose
α, β > 0.

Part a
What condition or conditions do α and β need to satisfy such that whenever the man-
ager of the firm doubles the inputs, the output is less than two times the original output?
What condition or conditions do α and β need to satisfy such that whenever the manager
of the firm doubles the inputs, the output is more than two times the original output?
What condition or conditions do α and β need to satisfy such that whenever the manager
of the firm doubles the inputs, the output is equal to two times the original output?

Answer: When the manager of the firm doubles the inputs, the output is f (2L, 2K) =
(2L)α (2K)β = 2α+β Lα K β . Thus,
• When α + β > 1, then the output is more than two times of the original output.

• When α + β = 1, then the output is equal to two times of the original output.

• When α + β < 1, then the output is less than two times of the original output.

Part b
Suppose β = 1 − α. Does the production function exhibit increasing, constant, or de-
creasing returns to scale? Is the marginal product of each factor diminishing?

Answer: Since we have f (tL, tK) = (tL)α (tK)1−α = tα+1−α Lα K 1−α = tf (L, K), the
production function f (L, K) = Lα K 1−α exhibits constant return to scale.
To check the marginal products of each factor, we take the first order derivatives of
the production function w.r.t. L and K respectively, giving:
∂f (L, K)
M PL = = αLα−1 K 1−α
∂L
∂f (L, K)
M PK = = (1 − α)Lα K −α
∂K
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To see whether these marginal products are diminishing, we take the first order derivative
of M PL and M PK w.r.t L and K respectively (which are equivalent of taking the second
order derivative of the production function w.r.t L and K respectively), giving:

∂M PL ∂ 2 f (L, K)
= = α(α − 1)Lα−2 K 1−α
∂L ∂L2
∂M PK ∂ 2 f (L, K)
= 2
= −(1 − α)αLα K −1−α
∂K ∂K
Since we must have 1 − α > 0, M PL is decreasing in L and M PK is decreasing in K.