Production

ES20011: Intermediate microeconomics 1

Autumn 2018

Exercise 1
1
A competitive firm’s production function is y = 10 + ( x − 1000) 3 . The price of input x is w = 1.

(i) Show that the firm’s total cost curve is C (y) = 1000 + (y − 10)3 .

(ii) Show that the minimum of the marginal cost curve is at y = 10, and the minimum of the
average cost curve is at y = 15.

(iii) Finally, show that the firm supplies

• zero output when p < 75

q
p
• y( p) = 10 + 3 when p ≥ 75

Solution 1
(i)

1
min C ( x ) = wx s.t. y = 10 + ( x − 1000) 3

Rewriting the production function gives us x = 1000 + (y − 10)3 . Plugging this into the
objective function gives C (y) = 1000 + (y − 10)3 since w = 1.

(ii) The derivative of the total cost function is the marginal cost function. Differentiating this
w.r.t. y and equating to zero gives us the turning point. Differentiating again and checking
the sign will tell us whether it is a minimum or a maximum.

MC (y) = C 0 (y) = 3 (y − 10)2

and

∂MC (y)
= 6 (y − 10) = 0 ⇒ y = 10
∂y
∂2 MC (y)
=6>0
∂y2

1
 implying a minimum.
For the average cost function

C (y) 1000 + (y − 10)3

AC (y) = =
y y

and

∂AC (y) 3(y − 10)2 1000 + (y − 10)3

= − =0⇒
∂y y y2
3y(y − 10)2 − 1000 − (y − 10)3
=0⇒
y2
(y − 10)2 (3y − y + 10) = 1000 ⇒
y = 15 (y 6= 0)

" #
∂2 AC (y) 3(y − 10)2 + 6y(y − 10) − 3(y − 10)2 3y(y − 10)2 − 1000 − (y − 10)3
= −
∂y2 y2 y3
6y2 (y − 10) − 3y(y − 10)2 + 1000 + (y − 10)3
=
y3
= 2 > 0 when evaluated at y = 15

implying a minimum

(iii) At y = 15, average costs are minimised and equal to 75. Therefore at any p < 75 and any
y > 0, average costs are greater than price and output will be zero.
At p ≥ 75 the firm will produce where p = MC (y), i.e.

p = 3 (y − 10)2
q
p
which yields y( p) = 10 + 3.

Exercise 2
Consider the production function

β
y = f ( x1 , x2 ) = x1α x2

where α and β are positive constants. Assume the input prices for x1 and x2 are given by w1
and w2 , respectively.

(i) Show that if α + β < 1, the production function has the property of decreasing returns to

2
 scale. Show that if α + β = 1, the production function exhibits constant returns to scale
and if α + β > 1, the production function exhibits increasing returns to scale.

(ii) Find the marginal products MP1 and MP2 , and the marginal technical rate of substitution,
MRTS.

(iii) Find the long-run cost function C (y), the average cost function AC (y), and the marginal
cost function MC (y).

Solution 2
(i) Note that

f (θx1 , θx2 ) = (θx1 )α (θx2 ) β = θ α+ β x1α x2

β

and

β
θ f ( x1 , x2 ) = θx1α x2

For θ > 1 there is

• DRS if f (θx1 , θx2 ) < θ f ( x1 , x2 )

• IRS if f (θx1 , θx2 ) > θ f ( x1 , x2 )
• CRS if θ f ( x1 , x2 ) = f (θx1 , θx2 )

(ii)

∂y
αx1α−1 x2
β
=



∂x1  αx2
⇒ MRTS =
∂y β −1  βx1
= βx1α x2



∂x2

(iii) Instead of

β
min w1 x1 + w2 x2 s.t. y = x1α x2
x1 ,x2

solve the problem

! α1
y
min w1 β
+ w2 x 2
x2 x2

3
to get

  α+β β
αw2 1
x1 = y α+ β
βw1
  α+α β
βw1 1
x2 = y α+ β
αw2

Plug into w1 x1 + w2 x2 to get

  β   α
αw2 α+β α+1 β βw1 α+β α+1 β
C ( y ) = w1 y + w2 y
βw1 αw2
 
  α+β β   α+α β
αw2 βw1 1
=  w1 + w2  y α+ β
βw1 αw2
1
= Ay α+β

It follows that
1
Ay α+β
AC (y) =
y
1− α − β
= Ay α+ β

and

d  α+1 β 
MC (y) = Ay
dy
A 1−α+α−β β
= y
a+b