Ch07solution Manual

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual
Chapter 7
Costs and Cost Minimization
Solutions to Review Questions
1. A biotechnology firm purchased an inventory of test tubes at a price of $0.50 per tube at
some point in the past. It plans to use these tubes to clone snake cells. Explain why the
opportunity cost of using these test tubes might not equal the price at which they were
acquired.
Acquisition cost and opportunity cost are not necessarily the same. As the text points out,
opportunity costs are forward looking. The opportunity cost is the payoff associated with the
best of the alternatives that are not chosen. Once the test tubes are purchased, the decision is to
use the tubes to clone snake cells or something else. It is possible that someone values the tubes
for some purpose at higher (or lower) than $0.50 so that selling the tubes would earn the firm
something more (or less) than $0.50 per tube. The opportunity cost then is different than the
acquisition cost.
2. You decide to start a business that provides computer consulting advice for students in
your residence hall. What would be an example of an explicit cost you would incur in
operating this business? What would be an example of an implicit cost you would incur in
operating this business?
Since the business is computer consulting, an explicit cost, a cost involving a direct monetary
outlay, might be the cost of paper and ink used to advertise your service. An implicit cost, a cost
not involving a direct monetary outlay, might be the opportunity cost of your time, e.g., to earn
money working at the student fitness center or to study for your own classes.
3. Why does the sunkness or nonsunkness of a cost depend on the decision being
made?
Whether or not a particular cost is sunk or not depends on the decision being made. If the cost
does not change as a result of the decision the cost is sunk, while if the cost does change the cost
is not sunk.
4. How does an increase in the price of an input affect the slope of an isocost line?
A firms total costs are TC = rK + wL, so the equation for a typical isocost line is
TC w
K
L.
r
r
Since the slope of the isocost line is given by w / r , if the price of labor increases the isocost
line will become steeper and if the price of capital increases the isocost line will become flatter.
Copyright 2014 John Wiley & Sons, Inc.
Chapter 7 - 1
5. Could the solution to the firms cost-minimization problem ever occur off the isoquant
representing the required level of output?
The solution to the firms cost minimization problem must lie on an isoquant. While the firm
could produce a given output with a combination of inputs not on the isoquant, say by using
more labor and more capital than necessary, a combination such as this would not be efficient
and therefore not cost minimizing.
6. Explain why, at an interior optimal solution to the firms cost-minimization problem, the
additional output that the firm gets from a dollar spent on labor equals the additional
output from a dollar spent on capital. Why would this condition not necessarily hold at a
corner point optimal solution?
To understand why at an interior optimum the additional output the firm gets from a dollar spent
on labor must equal the additional output the firm gets from a dollar spent on capital, assume
these were not equal. For example, suppose the firm could get more output from a dollar spent
on labor than on a dollar spent on capital. Then the firm could take one dollar away from capital
and reallocate it to labor. Since the firm gets more output from a dollar of labor than from a
dollar of capital, it will require the firm to spend less than one dollar on labor to offset the
decline in output from taking one dollar away from capital. This implies the firm can keep
output at the same level but do so at a lower cost. Therefore, if these amounts are not equal the
firm is not minimizing cost.
This requirement does not necessarily hold at a corner solution. While the firm could potentially
reduce cost by reallocating spending to the more productive input, at a corner solution, by
definition, the firm is not using one of the inputs. There is no further opportunity to reallocate
spending if the firm is spending nothing on one of the inputs, i.e., the firm cannot move to a
point where one of the inputs is negative.
7. What is the difference between the expansion path and the input demand curve?
The expansion path traces out the cost minimizing combinations of all inputs as the level of
output is increased (expanded) holding the prices of the inputs fixed. An input demand curve
traces out a firms cost minimizing quantity of one input as the price of that input varies holding
the level of output and the prices of the other inputs fixed.
8. In Chapter 5 you learned that, under certain conditions, a good could be a Giffen good:
An increase in the price of the good could lead to an increase, rather than a decrease, in the
quantity demanded. In the theory of cost minimization, however, we learned that, an
increase in the price of an input will never lead to an increase in the quantity of the input
used. Explain why there cannot be Giffen inputs.
Giffen goods arise when the income effect is so severely negative that it offsets the substitution
effect. This can happen because in consumer choice, income was an exogenous variable
therefore, changes in price affect both the relative substitutability of goods (via the tangency
condition) as well as the consumers purchasing power (via the budget constraint). By contrast,
Chapter 7 - 2
in the cost minimization problem output is exogenous while the expenditure is the objective
function. Thus, a change in an input price affects only the relative substitutability of inputs (via
the tangency condition) there is no corresponding effect on the production constraint, since
prices do not appear there. So while there is a substitution effect in cost minimization, there is
no corresponding income effect as in consumer choice. Therefore, increases in input prices
will always lead to decreases in the use of that input (except at corner solutions, where there
might be no change). So there cannot be a Giffen input.
9. For a given quantity of output, under what conditions would the short-run quantity
demanded for a variable input (such as labor) equal the quantity demanded in the long
run?
Assuming quantity is fixed, the short-run demand for a variable input would equal its long-run
demand if the level of the fixed input in the short run was cost minimizing for the quantity of
output being produced in the long run.
Solutions to Problems
7.1. A computer-products retailer purchases laser printers from a manufacturer at a price
of $500 per printer. During the year the retailer will try to sell the printers at a price higher
than $500 but may not be able to sell all of the printers. At the end of the year, the
manufacturer will pay the retailer 30 percent of the original price for any unsold laser
printers. No one other than the manufacturer would be willing to buy these unsold printers
at the end of the year.
a) At the beginning of the year, before the retailer has purchased any printers, what is the
opportunity cost of laser printers?
b) After the retailer has purchased the laser printers, what is the opportunity cost
associated with selling a laser printer to a prospective customer? (Assume that if this
customer does not buy the printer, it will be unsold at the end of the year.)
c) Suppose that at the end of the year, the retailer still has a large inventory of unsold
printers. The retailer has set a retail price of $1,200 per printer. A new line of printers is
due out soon, and it is unlikely that many more old printers will be sold at this price. The
marketing manager of the retail chain argues that the chain should cut the retail price by
$1,000 and sell the laser printers at $200 each. The general manager of the chain strongly
disagrees, pointing out that at $200 each, the retailer would lose $300 on each printer it
sells. Is the general managers argument correct?
a)
$500
b)
30% of $500, or $150
c)
By not lowering the price and assuming the firm cannot sell any more printers, the best
the firm can hope for is the $150 the firm can receive from the manufacturer. If the firm drops
the price to $200 and sells the printers on their own they can actually profit an additional $50
over their best available alternative.
Chapter 7 - 3
7.2. A grocery shop is owned by Mr. Moore and has the following statement of revenues
and costs:
Revenues
$250,000
Supplies
$25,000
Electricity
$6,000
Employee salaries $75,000
Mr. Moores salary $80,000
Mr. Moore always has the option of closing down his shop and renting out the land for
$100,000. Also, Mr. Moore himself has job offers at a local supermarket at a salary of
$95,000 and at a nearby restaurant at $65,000. He can only work one job, though. What are
the shops accounting costs? What are Mr. Moores economic costs? Should Mr. Moore
shut down his shop?
The accounting costs are simply the sum: 25,000 + 75,000 + 80,000 + 6,000 = $186,000 and the
shops accounting profit is $64,000 which means that Mr. Moores total gain from this venture is
80,000 + 64,000 = $144,000.
The economic costs also include the opportunity cost of the land rental ($100,000) and of Mr.
Moores next best alternative, which in this case is $95,000. That is, Mr. Moore loses $15,000 by
not choosing his next best alternative. Therefore Mr. Moores total economic costs are 186,000 +
100,000 + 15,000 = $301,000, which exceeds his revenues by $51,000.
If he were to shut down the shop, Mr. Moore would earn 100,000 + 95,000 = $195,000 which is
more than the $144,000 he currently earns (by precisely the $51,000 figure from above).
Therefore he should shut down the shop.
7.3. Last year the accounting ledger for an owner of a small drugstore showed the
following information about her annual receipts and expenditures. She lives in a taxfree country (so don't worry about taxes).
Revenues
$1,000,000
Wages paid to hired labor (other than herself)
$300,000
Utilities (fuel, telephone, water)
$ 20,000
Purchases of drugs and other supplies for the store
$500,000
Wages paid to herself
$100,000
She pays a competitive wage rate to her workers, and the utilities and drugs and
other supplies are all obtained at market prices. She already owns the building, so
she has no cash outlay for its use. If she were to close the business, she could avoid
all of her expenses, and, of course, would have no revenue. However, she could rent
out her building for $200,000. She could also work elsewhere herself. Her two
employment alternatives include working at another drugstore, earning wages of
$100,000, or working as a freelance consultant, earning $80,000. Determine her
accounting profit and her economic profit if she stays in the drug store business. If
the two are different, explain the difference between the two values you have
calculated.
Her accounting profit equals revenues less all of the expenses reflected in the ledger:
$1,000,000 - $300,000 - $20,000 - $500,000 - $100,000 = $80,000.
Chapter 7 - 4
All of the accounting costs are also economic costs. The first three expense items (wages
paid to hired labor, utilities, and purchases of drugs and supplies) are expenses in
competitive markets, so the opportunity cost is reflected in the market prices. Further, the
wages she pays herself are the same as the opportunity cost of her time, because the most
she could earn if she closes her business is $100,000 working at another drugstore.
The economic costs of the business include all of the accounting costs, plus the
$200,000 opportunity cost of the building because she could earn that if she exits the drug
store business. Her economic profit is her accounting profit ($80,000) less the additional
opportunity cost ($200,000) not included in the accounting cost. So her economic profit
is actually -$120,000.
We can look at this another way. If she continues to work at the grocery store, she
earns an accounting profit of $80,000, plus the salary she pays herself ($100,000). But if
she exits the business, her salary working for another drugstore would be $100,000, and
she would receive $200,000 rent for the building. She would therefore be better off by
$120,000 if she takes the job working for another drugstore.
7.4. A consulting firm has just finished a study for a manufacturer of wine. It has
determined that an additional man-hour of labor would increase wine output by 1,000
gallons per day. Adding another machine-hour of fermentation capacity would increase
output by 200 gallons per day. The price of a man-hour of labor is $10 per hour. The price
of a machine-hour of fermentation capacity is $0.25 per hour. Is there a way for the wine
manufacturer to lower its total costs of production and yet keep its output constant? If so,
what is it?
At the optimum we must have
MPK MPL
r
w
In this problem we have
200 1000
0.25
10
800 100
This implies that the firm receives more output per dollar spent on an additional machine hour of
fermentation capacity than for an additional hour spent on labor. Therefore, the firm could lower
cost while achieving the same level of output by using fewer hours of labor and more hours of
fermentation capacity.
7.5. A firm uses two inputs, capital and labor, to produce output. Its production function
exhibits a diminishing marginal rate of technical substitution.
a) If the price of capital and labor services both increase by the same percentage amount
(e.g., 20 percent), what will happen to the cost-minimizing input quantities for a given
output level?
Chapter 7 - 5
b) If the price of capital increases by 20 percent while the price of labor increases by 10
percent, what will happen to the cost-minimizing input quantities for a given output level?
a)
If the price of both inputs change by the same percentage amount, the slope of the isocost
line will not change. Since we are holding the level of output fixed, the isocost line will be
tangent to the isoquant at the same point as prior to the price increase. Therefore, the costminimizing quantities of the inputs will not change.
b)
If the price of capital increases by a larger percentage than the price of labor, then,
relatively speaking, the price of labor has become cheaper. The firm will substitute away from
capital and add labor until either the tangency condition holds or a corner solution is reached.
7.6. A farmer uses three inputs to produce vegetables: land, capital, and labor. The
production function for the farm exhibits diminishing marginal rate of technical
substitution.
a) In the short run the amount of land is fixed. Suppose the prices of capital and labor both
increase by 5 percent. What happens to the cost-minimizing quantities of labor and capital
for a given output level? Remember that there are three inputs, one of which is fixed.
b) Suppose only the cost of labor goes up by 5 percent. What happens to the costminimizing quantity of labor and capital in the short run?
a)
The amount of land used in production is fixed in the short-run. Hence, in the short-run
the farmer chooses amount of capital and labor. It follows that cost-minimizing quantities of
labor and capital have to satisfy equation MPL / MPK = w/r where w and r denote prices of labor
and capital. Notice that w/r = (1.05 w)/ (1.05 r). The cost-minimizing quantities of inputs, for
each level of output, do not change when prices of both inputs go up by 5% and quantity of land
is fixed.
b)
For a given output level, the cost-minimizing farmer uses more capital and less labor.
7.7. The text discussed the expansion path as a graph that shows the cost-minimizing input
quantities as output changes, holding fixed the prices of inputs. What the text didnt say is
that there is a different expansion path for each pair of input prices the firm might face. In
other words, how the inputs vary with output depends, in part, on the input prices.
Consider, now, the expansion paths associated with two distinct pairs of input prices, (w1,
r1) and (w2, r2). Assume that at both pairs of input prices, we have an interior solution to the
cost-minimization problem for any positive level of output. Also assume that the firms
isoquants have no kinks in them and that they exhibit diminishing marginal rate of
technical substitution. Could these expansion paths ever cross each other at a point other
than the origin (L = 0, K = 0)?
Imagine that two expansion paths did cross at some point. Recall that the expansion path traces
out the cost- minimizing combinations of inputs as output increases. Essentially the expansion
path traces out all of the tangencies between the isocost lines and isoquants. These tangencies
occur at the point where
Chapter 7 - 6
MPL w
MPK r
If the expansion paths cross at some point then the cost minimizing combination of inputs must
be identical with both sets of prices. This would require that
MPK MPL
MPK MPL
and
r1
w1
r2
w2
Unless the input prices are proportional, i.e. unless w1 / r1 = w2 / r2, it is not possible for both of
these equations to hold. Therefore, it is not possible for the expansion paths to cross unless the
prices are proportional, in which case the two expansion paths will be identical.
7.8. Suppose the production of airframes is characterized by a CES production function:
Q = (L + K)2. The marginal products for this production function are MPL = (L + K)L
and MPK = (L+ K)K. Suppose that the price of labor is $10 per unit and the price of
capital is $1 per unit. Find the cost-minimizing combination of labor and capital for an
airframe manufacturer that wants to produce 121,000 airframes.
The tangency condition implies
L1/ 2 K 1/ 2 K 1/ 2 L1/ 2 K 1/ 2 L1/ 2
r
w
1
1
r K w L
w L r K
Given that w 10 and r 1 , this implies
K w2
L r2
K
L
100 L K
100
Returning to the production function and assuming Q 121, 000 yields
Chapter 7 - 7
121, 000 L1/ 2 K 1/ 2
121, 000 L1/ 2 (100 L)1/ 2

121, 000 L1/ 2 10 L1/ 2
121, 000 11L1/ 2
121, 000 121L
1, 000 L
Since K 100 L , K 100(1000) 100, 000 . The cost minimizing quantities of capital and labor
to produce 121,000 airframes is K 100, 000 and L 1, 000 .
7.9. Suppose the production of airframes is characterized by a CobbDouglas production
function: Q = LK. The marginal products for this production function are MPL = K and
MPK = L. Suppose the price of labor is $10 per unit and the price of capital is $1 per unit.
Find the cost-minimizing combination of labor and capital if the manufacturer wants to
produce 121,000 airframes.
The tangency condition implies
K
L
10 L K
10
Substituting into the production function yields

121, 000 LK
121, 000 L(10 L)
121, 000 10 L2
12,100 L2
110 L
Since K 10 L , K 1,100 . The cost-minimizing quantities of labor and capital to produce
121,000 airframes are K 1,100 and L 110 .
7.10. The processing of payroll for the 10,000 workers in a large firm can either be done
using 1 hour of computer time (denoted by K) and no clerks or with 10 hours of clerical
time (denoted by L) and no computer time. Computers and clerks are perfect substitutes;
for example, the firm could also process its payroll using 1/2 hour of computer time and 5
hours of clerical time.
a) Sketch the isoquant that shows all combinations of clerical time and computer time that
allows the firm to process the payroll for 10,000 workers.
Chapter 7 - 8
b) Suppose computer time costs $5 per hour and clerical time costs $7.50 per hour. What
are the cost-minimizing choices of L and K? What is the minimized total cost of processing
the payroll?
c) Suppose the price of clerical time remains at $7.50 per hour. How high would the price of
an hour of computer time have to be before the firm would find it worthwhile to use only
clerks to process the payroll?
a)
1.2
1
0.8
0.6
0.4
0.2
0
0
10
12
K and L are perfect substitutes, meaning that the production function is linear and the isoquants
are straight lines. We can write the production function as Q = 10,000K + 1000L, where Q is the
number of workers for whom payroll is processed.
b)
If r 5 and w 7.50 , the slope of a typical isocost line will be 7.5 / 5.0 1.5 . This is
steeper than the isoquant implying that the firm will employ only computer time ( K ) to
minimize cost. The cost minimizing combination is K 1 and L 0 . This outcome can be seen
in the graph below. The isocost lines are the dashed lines.
2.5
2
Optimum
1.5
1
0.5
0
0
10
12
The total cost to process the payroll for 10,000 workers will be TC 5(1) 7.5(0) 5 .
c)
The firm will employ clerical time only if MPL / w > MPK / r. Thus we need 0.1 / 7.5 >
1/r or r > 75.
Chapter 7 - 9
7.11. A firm produces an output with the production function Q = KL, where Q is the
number of units of output per hour when the firm uses K machines and hires L workers
each hour. The marginal products for this production function are MPK = L and MPL = K.
The factor price of K is 4 and the factor price of L is 2. The firm is currently using K = 16
and just enough L to produce Q = 32. How much could the firm save if it were to adjust K
and L to produce 32 units in the least costly way possible?
Currently the firm must be using L = Q/K = 32/16 = 2 units of labor. Let the factor prices of
capital and labor be, respectively, r and w.
Its total expenditure is C = wL + rK = 2(2) + 4(16) = 68.
If it were to minimize cost, it would hire L and K so that (1) MPK/r = MPL/w, or L/4 = K/2, or L
= 2K and (2) Q = LK.
(1) and (2) imply that Q = 2K2, or 32 = 2K2, and thus K = 4 and L = 8.
So Q = 32 can be produced efficiently with a cost of C = wL + rK = 2(8) + 4(4) = 32.
The firm could save 68 32 = 36 by producing efficiently.
7.12. A firm operates with the production function Q = K2L. Q is the number of
units of output per day when the firm rents K units of capital and employs L
workers each day. The marginal product of capital is 2KL, and the marginal
product of labor is K2. The manager has been given a production target: Produce
8,000 units per day. She knows that the daily rental price of capital is $400 per unit.
The wage rate paid to each worker is $200 day.
a) Currently the firm employs at 80 workers per day. What is the firms daily total
cost if it rents just enough capital to produce at its target?
b) Compare the marginal product per dollar sent on K and on L when the firm
operates at the input choice in part (a). What does this suggest about the way the
firm might change its choice of K and L if it wants to reduce the total cost in meeting
its target?
c) In the long run, how much K and L should the firm choose if it wants to minimize
the cost of producing 8,000 units of output day? What will the total daily cost of
production be?
a) Suppose that the firm is operating in the short run, with L = 80. To produce Q = 8,000,
how much K will it require? From the production function we observe that 8,000 = K2
(80) => K = 10.
The total cost would be C = wL + rK = $200(80) + $400(10) = $2,000 per day.
b) Lets examine the bang for the buck for K and L when K = 10 and L = 80.
For capital: MPK / r = 2KL / 400 = 2(10)(80) / 400 = 4
For labor: MPL / w = K2 / 200 = 102 / 200 = 0.5
So the marginal product per dollar spent on capital exceeds that of labor. The firm would
like to rent more capital and hire fewer workers.
Chapter 7 - 10
c) Because the production function is Cobb-Douglas, we know that it has diminishing

MRTSL,K and that the isoquants do not intersect either the K or L axis. Thus the cost
reducing basket (K,L) will be interior (with K > 0 and L > 0). To find the optimum, we
use the two conditions:
(1) Tangency condition:
MPK / MPL = r / w => 2KL/K2 = 400 / 200 => K = L
(2) Production Requirement:
K2L = 8,000
Together equations (1) and (2) tell us that K = 20 and L = 20.
The total cost would be C = wL + rK = $200(20) + $400(20) = $12,000 per day.
7.13. Consider the production function Q = LK, with marginal products MPL = K and MPK
= L. Suppose that the price of labor equals w and the price of capital equals r. Derive
expressions for the input demand curves.
From the tangency condition, we get
K w
L r
w
K L
r
Substituting into the production function yields
Q LK
w
L
r
w 2
L
r
Q L
rQ
L
1/ 2
This represents the input demand curve for L . Since

w
L
r
K
we have
w
K
r
wQ
rQ
1/ 2
1/ 2
This represents the input demand curve for K .
Chapter 7 - 11
7.14. A cost-minimizing firms production function is given by Q = LK, where MPL = K and
MPK = L. The price of labor services is w and the price of capital services is r. Suppose you
know that when w = $4 and r = $2, the firms total cost is $160. You are also told that when
input prices change such that the wage rate is 8 times the rental rate, the firm adjusts its
input combination but leaves total output unchanged. What would the cost-minimizing
input combination be after the price changes?
Using the tangency condition, with the original input prices:
K w
2 . So, K = 2L. Also, using
L
r
the information on total costs, 4 L 2 K 160. Combining these two equations, we get (L, K) =
(20, 40). Therefore the firm produces 20*40 = 800 units of output.
After the prices change, even though we dont know the numerical values of the input prices, we
can still answer the question using the fact that were told w = 8r. The tangency condition
implies that
K
8, so K = 8L. Also, we have KL 800 . This implies that the optimal input
L
combination is (L, K) = (10, 80).

7.15. Ajax, Inc. assembles gadgets. It can make each gadget either by hand or with a
special gadget-making machine. Each gadget can be assembled in 15 minutes by a worker
or in 5 minutes by the machine. The firm can also assemble some of the gadgets by hand
and some with machines. Both types of work are perfect substitutes, and they are the only
inputs necessary to produce the gadgets.
a) It costs the firm $30 per hour to use the machine and $10 per hour to hire a worker. The
firm wants to produce 120 gadgets. What are the cost-minimizing input quantities?
Illustrate your answer with a clearly labeled graph.
b) What are the cost-minimizing input quantities if it costs the firm $30 per hour to use the
machine, and $10 per hour to hire a worker? Illustrate your answer with a graph.
c) Write down the equation of the firms production function for the firm. Let G be the
number of gadgets assembled, M the number of hour the machines are used, and L the
number of hours of labor.
a)
Isoquants for the production function are straight lines. At the given input prices slope of
an isoquant is equal to the ratio of the input prices. Hence, all positive input quantities (measured
in work hours) such that 4L + 12M = 120 are cost-minimizing.
Chapter 7 - 12
Cost-minimizing
inputs when
pm = $30, pw = $10.
10
hours
30 hours
b)
When one hour of the machines work costs $20 cost-minimizing firm does not use
manual work at all. The cost-minimizing quantity of the machines work necessary to produce
120 widgets is equal to M = 120/12 = 10 hours. The firm spends $200. (Note that if the firm were
to use only manual labor, the cost would be $300 = 30 hours x $10 per hour).
Cost-minimizing
inputs when
pm = $20, pw = $10.
10
hours
Isoquant line
G = 120
Isocost line
Total Cost = $200
30 hours
c)
G = 4L + 12M
7.16. A construction company has two types of employees: skilled and unskilled. A skilled
employee can build 1 yard of a brick wall in one hour. An unskilled employee needs twice
Chapter 7 - 13
as much time to build the same wall. The hourly wage of a skilled employee is $15. The
hourly wage of an unskilled employee is $8.
a) Write down a production function with labor. The inputs are the number of hours of
skilled workers, LS, the number of hours worked by unskilled employees, LU, and the
output is the number of yards of brick wall, Q.
b) The firm needs to build 100 yards of a wall. Sketch the isoquant that shows all
combinations of skilled and unskilled labor that result in building 100 yards of the wall.
c) What is the cost-minimizing way to build 100 yards of a wall? Illustrate your answer on
the graph in part (b).
a)
The production function is Q = LS + LU where LS denotes hours worked by skilled
workers and LU denotes hours worked by unskilled workers. Both types of labor are perfect
substitutes.
b)
The isoquant is a straight line.
LS
100h
Isoquant representing 100
yards of wall
Isocost line representing

$1500 expenditure
175h
200h
LU
c)
MPLs/ws = 1/15; MPLu/wu = 0.5/8 = 1/16. Thus, the bang for the buck is higher for
skilled labor, and the firm will use only skilled labor.
Note that the total cost of building 100 yards with skilled labor is (100 hours)($15/ hour) =
$1500.
The total cost of building 100 yards with unskilled labor is (200 hours)($8/ hour) = $1600.
The isocost line representing a $1500 expenditure is drawn as a dotted line in the graph in (b).
The isocost line is more steeply sloped than the isoquant in the graph because the marginal rate
of technical substitution of unskilled labor for unskilled labor is equal to , while the ratio of
input prices is equal to 8/15.
Chapter 7 - 14
7.17. A paint manufacturing company has a production function Q = K + L. For this

production function MPK = 1 and MPL = 1/(2L). The firm faces a price of labor w that
equals $1 per unit and a price of capital services r that equals $50 per unit.
a) Verify that the firms cost-minimizing input combination to produce Q = 10 involves no
use of capital.
b) What must the price of capital fall to in order for the firm to use a positive amount of
capital, keeping Q at 10 and w at 1?
c) What must Q increase to for the firm to use a positive amount of capital, keeping w at 1
and r at 50?
a)
First, note that this production function has diminishing MRSL,K. The tangency condition
would imply that 1 / 2 L 1 / 50 or L = 625. Substituting this back into the production function
we see that K = 10 25 = 15. Since the firm cannot use a negative amount of capital, the
tangency condition is not valid in this case.
Looking at the corner with K = 0, since Q = 10 the firm requires L = Q2 = 100 units of labor. At
this point, MPL / w = (1/20)/1 = 0.05 > MPK / r = 1/50 = 0.02. Since the marginal product per
dollar is higher for labor, the firm will use only labor and no capital.
b)
MPL
MPK
, or 2 L r. Thus L
w
r
= 10 0.5r. So if K > 0 then we must
The firm will use a positive amount of capital when
= 0.25r2. From the production constraint K =

have 10 0.5r > 0, or r < 20.
c)
Again, using the tangency condition we must have 2 L r. Therefore, since r = 50, L =
625. From the production constraint, the input demand for capital is K = Q L = Q 25. So
if K > 0 then we must have Q > 25.
7.18. A researcher claims to have estimated input demand curves in an industry in which
the production technology involves two inputs, capital and labor. The input demand curves
he claims to have estimated are L = wr2Q and K = w2rQ. Are these valid input demand
curves? In other words, could they have come from a firm that minimizes its costs?
No, these are not valid input demand curves. In both cases the quantity of the input is positively
related to the inputs price. Such upward-sloping input demand curves cannot exist.
7.19. A manufacturing firms production function is Q = KL + K + L. For this production
function, MPL = K + 1 and MPK = L + 1. Suppose that the price r of capital services is equal
to 1, and let w denote the price of labor services. If the firm is required to produce 5 units of
output, for what values of w would a cost-minimizing firm use
a) only labor?
b) only capital?
c) both labor and capital?
Chapter 7 - 15
If K = 0, then the firm must hire L = 5 units of labor. For this to be optimal, it must be that
MPL / w > MPK / r, or 1/w > 6. In other words, w < 1/6.
If L = 0, then the firm must hire K = 5 units of capital. For this to be optimal, it must be that
MPL / w < MPK / r, or 6/w > 1. In other words, w > 6.
For the firm to use both capital and labor, it must be that 1/6 < w < 6. To see why, notice that the
indifference curves will have diminishing MRTSL,K. In particular, MRTSL,K = 6 where the Q = 5
indifference curve intersects the K-axis (where L = 0). Diminishing MRTSL,K implies that the Q
= 5 indifference curve will gradually flatten out until it intersects the L-axis (where K = 0), at
which point MRTSL,K = 1/6.
7.20. Suppose a production function is given by Q = min(L, K)that is, the inputs are
perfect complements. Draw a graph of the demand curve for labor when the firm wants to
produce 10 units of output (Q = 10).
The input demand curves will be vertical lines, representing the fact that the demand by firms for
such inputs is inelastic. If the firms production function is Q min( L, K ) then, holding fixed
the quantity of production and the price of capital, if the wage rate were to increase it would not
change the firms requirement for labor. Therefore, the demand for each input is independent of
price and the demand curves are vertical lines.
7.21. A firms production function is Q = min(K , 2L), where Q is the number of
units of output produced using K units of capital and L units of labor. The factor
prices are w = 4 (for labor) and r = 1 (for capital). On an optimal choice diagram
with L on the horizontal axis and K on the vertical axis, draw the isoquant for Q =
12, indicate the optimal choices of K and L on that isoquant, and calculate the total
cost.
The isoquant Q = 12 is shown for this Leontief technology. To produce Q = 12, the firm
will need at least K = 12 and L = 6. This will cost the firm C = wL + rK = 4(6) + 1(12) =
36. The isocost line representing an expenditure of 36 is drawn. The optimal basket of
inputs is A.
K
12
Q = 12
Isocost C = 36
Isocost line has slope -w/r = -4
Chapter 7 - 16
7.22. Suppose a production function is given by Q = K + Lthat is, the inputs are perfect
substitutes. For this production function, MPL = 1 and MPK = 1. Draw a graph of the
demand curve for labor when the firm wants to produce 10 units of output and the price of
capital services is $1 per unit (Q = 10 and r = 1).
Recall that with a linear production function we are usually going to get corner point solutions.
In this case, the firm will employ only labor and no capital if labor is cheap enough or,
MPL MPK
br
i.e. if w . Similarly it will use just capital if the rental rate is low enough i.e.
a
w
r
aw
Q
. If the firm uses only labor, it will use L
units regardless of the price, and similarly
b
a
Q
it will use K
units of capital if it uses any capital at all. The input demand curve for labor
b
r
for a given price, r, of capital, is shown below.

w
br/a
Q/a
7.23. Suppose a production function is given by Q = 10K + 2L. The factor price of labor is
1. Draw the demand curve for capital when the firm is required to produce Q = 80.
With this production function the firm views K and L as perfect substitutes.
The firm will be at a corner point with K = 0 when MPK/r < MPL/w, or when 10/r <2/1, or when r
> 5.
The firm will be at a corner point with L = 0 when MPK/r > MPL/w, or when 10/r >2/1, or when r
< 5. When the firm needs to produce Q = 80, how much capital will it need? The production
function shows that 80 = 10K, or K = 8 units.
When r = 5, the firm might use any combination of K and L along the isoquant 80 = 10K + 2L.
The firm might therefore use any K such that 0 < K < 8.
The graph of the demand for labor is as shown.
Chapter 7 - 17
Demand for Capital

(Heavy curve)
K
8
7.24. Consider the production function Q = K + L. For this production function, MPL = 1/
(2L) and MPK = 1. Derive the input demand curves for L and K, as a function of the input
prices w (price of labor services) and r (price of capital services). Show that at an interior
optimum (with K > 0 and L > 0) the amount of L demanded does not depend on Q. What
does this imply about the expansion path?
The tangency condition implies that
1
2 L
w
, or
r
r
. Clearly the demand curve for L is
2w
not a function of the level of output, Q. Therefore, as the level of output changes, the amount of
labor is constant. Therefore, if we were to graph isoquants with labor on the horizontal axis, the
expansion path for labor would just be a straight, vertical line.
The demand curve for capital can be derived by substituting the demand curve for labor into the
production function. That is, K
r
r
Q, so K Q
.
2w
2w
7.25. A firm has the production function Q = LK. For this production function, MPL = K
and MPK = L. The firm initially faces input prices w = $1 and r = $1 and is required to
produce Q = 100 units. Later the price of labor w goes up to $4. Find the optimal input
combinations for each set of prices and use these to calculate the firms price elasticity of
demand for labor over this range of prices.
Using the tangency condition, initially
K
1 , implying that K = L. Since KL = 100, we get K =
L
L = 10.
Under the new prices, the tangency condition implies that K=4L. This means that the optimal
input combination is (L, K) = (5, 20).
The percent change in price is (4 1)*100 = 300%. While the percent change in the demand for
labor is [(5 10)/10]*100 = 50%. Therefore the price elasticity of demand over this range of
prices is 50/300 = 1/6.
7.26 A bicycle is assembled out of a bicycle frame and two wheels.
a) Write down a production function of a firm that produces bicycles out of frames and
wheels. No assembly is required by the firm, so labor is not an input in this case. Sketch the
Chapter 7 - 18
isoquant that shows all combinations of frames and wheels that result in producing 100
bicycles.
b) Suppose that initially the price of a frame is $100 and the price of a wheel is $50. On the
graph you drew for part (a), show the choices of frames and wheels that minimize the cost
of producing 100 bicycles, and draw the isocost line through the optimal basket. Then
repeat the exercise if the price of a frame rises to $200, while the price of a wheel remains
$50.
a)
The production function is Q = min(F, W), where F denotes the number of frames and
W denotes the number of wheels.
frames
200
100
Initial Isocost Line:

$20,000
100 bicycle isoquant

Final Isocost Line:
$30,000
400
200
wheels
600
b)
To produce 100 bicycles in the least costly manner, the firm always needs to choose
basket A, with 200 wheels and 100 frames.
Initially, when the price of a frame is $100 and the price of a wheel is $50, the isocost line is the
lighter one shown in the graph; all points on the isocost line indicate an expenditure of $20,000.
Later, when the price of a frame is $200 and the price of a wheel is $50, the isocost line is the
lighter one shown in the graph; all points on the isocost line indicate an expenditure of $30,000.
7.27. Suppose that the firms production function is given by Q = 10KL1/3. The firms
capital is fixed at K. What amount of labor will the firm hire to solve its short-run costminimization problem?
With just two inputs, there is no tangency condition to worry about in the short run. To find the
short-run cost-minimizing quantity of labor, we need only solve the production function for L in
terms of Q and K :
1
Q 10 KL3
This gives us:
Chapter 7 - 19
Q3
1000 K
This is the cost-minimizing quantity of labor in the short run.

7.28. A plants production function is Q = 2KL + K . For this production function, MPK =
2L + 1 and MPL = 2K. The price of labor services w is $4 and of capital services r is $5 per
unit.
a) In the short run, the plants capital is fixed at K = 9. Find the amount of labor it must
employ to produce Q = 45 units of output.
b) How much money is the firm sacrificing by not having the ability to choose its level of
capital optimally?
a)
Since K 9 , we get 18L 9 45 which implies that L = 36/18 = 2. Therefore the firms
total cost with this input combination is 4(2) + 5(9) = $53.
b)
If the firm could operate optimally, it would choose labor and capital to satisfy the
tangency condition:
2K
4
, implying that 10 K 8 L 4. Also, 2 KL K 45. Combining
2L 1 5
these two conditions, K 18 = 4.24 and L = 4.8. Now the firms expenditure would be 4(4.24)
+ 5(4.8) = $41 approximately. Therefore the firm loses about $12 because of its constraint on
capital.
7.29. Suppose that the firm uses three inputs to produce its output: capital K, labor L, and
materials M. The firms production function is given by Q = K1/3L1/3M1/3. For this production
function, the marginal products of capital, labor, and materials are MPK = 1/3K2/3L1/3M1/3,
MPL = 1/3K1/3L2/3M1/3, and MPM = 1/3K1/3L1/3M2/3. The prices of capital, labor, and materials
are r = 1, w = 1, and m = 1, respectively.
a) What is the solution to the firms long-run cost minimization problem given that the firm
wants to produce Q units of output?
b) What is the solution to the firms short-run cost minimization problem when the firm
wants to produce Q units of output and capital is fixed at K?
c) When Q = 4, the long-run cost-minimizing quantity of capital is 4. If capital is fixed at K
= 4 in the short run, show that the short-run and long-run cost-minimizing quantities of
labor and materials are the same.
a)
Here we have two tangency conditions and the requirement that L , K , and M produce
Q units of output.
Chapter 7 - 20
1
K 3L 3M 3 1
MPL w
3 1 1 2 M L
1
3 3
3
MPM m
1
3 K L M
1
K 3L 3M 3 1
MPL w
3 2 1 1 K L
1
3
MPK r
L3 M 3 1
3 K
1
Q K 3 L3 M 3
This is a system of three equations in three unknowns. The solution to this system gives us the
long-run cost-minimizing input combination:
LQ
M Q
K Q
b)
The tangency condition
MPL
MPM
1
3
1
3
w
m
is
1
1
3
1
3
K 3L 3M 3
K LM
1
,
1
32
which implies
M L
To find the short-run cost-minimizing quantity of labor, we plug this back into the production
function and solve for L in terms of Q and K .
1
Q K 3 L3 L3
which when we solve for L gives us the short-run cost-minimizing quantity of labor
3
Q2
1
K2
Since M L , the short-run cost-minimizing quantity of materials is

3
Q2
1
K2
c)
Plugging Q 4 into the expressions for the long-run cost-minimizing quantities of labor
and materials gives us
Chapter 7 - 21
L4
M 4
Plugging Q 4 and K 4 into the expressions for the short-run cost-minimizing quantities of
labor and materials gives us
3
42
4
1
2
( 32 12 )
( 32 12 )
42
4
1
2
7.30. Consider the production function in Learning-By-Doing Exercise 7.6: Q = L + K +

M. For this production function, the marginal products of labor, capital, and materials are
MPL = 1/(2L), MPK = 1/(2K), and MPM = 1/(2M). Suppose that the input prices of labor,
capital, and materials are w = 1, r = 1, and m = 1, respectively.
a) Given that the firm wants to produce Q units of output, what is the solution to the firms
long-run cost minimization problem?
b) Given that the firm wants to produce Q units of output, what is the solution to the firms
short-run cost minimization problem when K = 4? Will the firm want to use positive
quantities of labor and materials for all levels of Q?
(c) Given that the firm wants to produce 12 units of output, what is the solution to the
firms short-run cost minimization problem when K = 4 and L = 9? Will the firm want to
use a positive quantity of materials for all levels of Q?
a)
With three inputs, we need two tangency conditions to ensure that the marginal product
per dollar spent is equal across all inputs. (We could write down a third tangency condition, but
it would be redundant.) Equating the bang for the buck between labor and capital implies
1 2 L 1 2 K or L = K. Similarly, equating the bang for the buck between labor and
materials implies 1 2 L 1 2 M or L = M. Then using the production constraint to find the
input demand for labor yields Q L L L or L = (1/3)Q2. Since L = M = K from the
tangency conditions, we also have K = (1/3)Q2 and M = (1/3)Q2.
b)
First, note that with K = 4, the firm can produce up to Q = 0 4 0 = 2 units of
output without hiring any labor or materials. To produce more than Q = 2, the firm still balances
the marginal product per dollar spent on labor and materials; in part (a), we saw this implied L =
M. Substituting this and K = 4 into the production constraint, we have Q = L 4 L which
yields L = (1/4)(Q 2)2 as the input demand for labor. Then L = M implies that the input
demand for materials is M = (1/4)(Q 2)2. Therefore, the input demand functions are
0
Q2
2
1
4 Q 2 Q 2
L Q M Q
Chapter 7 - 22
c)
Again, with K = 4 and L = 9, the firm can produce up to Q = 5 units of output without
hiring any materials. Should it desire to produce greater levels of output, it can hire materials
according to Q = 9 4 M , or M = (Q 5)2. Therefore, the input demand for materials is
0
Q5
M Q
2
Q 5 Q 5
7.31. Acme, Inc. has just completed a study of its production process for gadgets. It uses
labor and capital to produce gadgets. It has determined that 1 more unit of labor would
increase output by 200 gadgets. However, an additional unit of capital would increase
output by 150 gadgets. If the current price of capital is $10 and the current price of labor is
$25, is the firm employing the optimal input bundle for its current output? Why or why
not? If not, which inputs usage should be increased?
The information in the problem tells us that MPL = 200 and MPK = 150 while w = 25 and r = 10.
So MPL/w = 8 < MPK/r = 15. Thus Acme could maintain its current level of output while
reducing costs by employing more capital and less labor. So it is not employing the optimal
input bundle.
7.32. A firm operates with a technology that is characterized by a diminishing marginal
rate of technical substitution of labor for capital. It is currently producing 32 units of
output using 4 units of capital and 5 units of labor. At that operating point the marginal
product of labor is 4 and the marginal product of capital is 2. The rental price of a unit of
capital is 2 when the wage rate is 1. Is the firm minimizing its total long-run cost of
producing the 32 units of output? If so, how do you know? If not, show why not and
indicate whether the firm should be using (i) more capital and less labor, or (ii) less capital
and more labor to produce an output of 32.
We have MPL/w = 4/1 = 4 > MPK/r = 2/2 = 1. Thus the firm cannot be minimizing its long-run
total cost. By employing more labor and less capital, it could maintain 32 units of output while
lowering total costs.
7.33. Suppose that in a given production process a blueprint (B) can be produced using
either an hour of computer time (C) or 4 hours of a manual draftsmans time (D). (You may
assume C and D are perfect substitutes. Thus, for example, the firm could also produce a
blueprint using 0.5 hour of C and 2 hours of D.)
a) Write down the production function corresponding to this process (i.e., express B as a
function of C and D).
b) Suppose the price of computer time (pc) is 10 and the wage rate for a manual draftsman
(pD) is 5. The firm has to produce 15 blueprints. What are the cost minimizing choices of C
and D? On a graph with C on the horizontal axis and D on the vertical axis, illustrate your
answer showing the 15-blueprint isoquant and isocost lines.
Chapter 7 - 23
a)
Computers are four times as productive as draftsmen; an alternative way of saying this is
that MPC = 4MPD. Since C and D are perfect substitutes, we know the production function has
the form B = aC + bD, where a and b are positive constants. Thus we can write the production
function as B = C + (1/4)D. Note that this is consistent with generating one blueprint (B = 1)
from the following combinations of inputs: (C, D) = (1, 0), (C, D) = (0, 4), and (C, D) = (0.5, 2).
b)
Notice that MPC pC 1 / 10 MPD pD 0.25 / 5 1 / 20 . That is, the marginal product
per dollar spent on computer time is always higher than the marginal product per dollar spent on
draftsman time. So the optimal input combination involves D = 0 and C = 15. The graph below
illustrates the (dotted) isocost lines with slope = pC / pD = 2, along with the (solid) B = 15
isoquant with slope = MPC / MPD = 4.
7.34. This problem will enable you to apply a revealed preference argument to see if
a firm is minimizing the total cost of production. The firm produces output with a
technology characterized by a diminishing marginal rate of technical substitution of
labor for capital. It is required to produce a specified amount of output, which does
not change in this problem. When faced with input prices w1 and r1, the firm chooses
the basket of inputs at point A on the graph below, and it incurs the total cost on the
isocost line IC1. When the factor prices change to w2 and r2 the firms choice of
inputs is at basket B, on isocost line IC2. Basket A lies on the intersection of the two
isocost lines. Are these choices consistent with cost minimizing behavior?
K
IC1
A
B
IC2
L
Chapter 7 - 24
Since the firms production remains unchanged, it must be producing the same level of
output at both points A and B. That is, the isoquant through A also passes through B. Now,
suppose that the firm is minimizing costs at point B. Then the isoquant through B is
tangent to isocost line IC2 . Since we are told that the MRTS is diminishing, there is no
way the isoquant passing through B can also pass through A. You can see this easily from
the graph. And you can also reach this conclusion using the property that a line tangent to
a curve does not intersect the curve at any point other than the point of tangency.
Similarly, if the firm were minimizing costs at A, then isocost line IC1 would be tangent
to the isoquant; but then it would be impossible for isocost line IC2 also to be tangent.
Thus, it is not possible for both A and B to be cost minimizing input combinations.
Chapter 7 - 25

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Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Given that w 10 and r 1 , this implies

Returning to the production function and assuming Q 121, 000 yields

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Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

121, 000 L1/ 2 K 1/ 2

121, 000 L1/ 2 (100 L)1/ 2

Substituting into the production function yields

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

c) Because the production function is Cobb-Douglas, we know that it has diminishing

This represents the input demand curve for L . Since

This represents the input demand curve for K .

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

combination is (L, K) = (10, 80).

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

The isoquant is a straight line.

Isocost line representing

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Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

7.17. A paint manufacturing company has a production function Q = K + L. For this

The firm will use a positive amount of capital when

= 0.25r2. From the production constraint K =

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

for a given price, r, of capital, is shown below.

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Demand for Capital

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Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Initial Isocost Line:

100 bicycle isoquant

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

This is the cost-minimizing quantity of labor in the short run.

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

The tangency condition

Since M L , the short-run cost-minimizing quantity of materials is

Copyright 2014 John Wiley & Sons, Inc.