Microeconomics Solutions 02

Chapter 2
The Firm
Exercise 2.1 Suppose that a unit of output can be produced by any of the
following combinations of inputs
z
1
=
_
0.2
0.5
_
, z
2
=
_
0.3
0.2
_
, z
3
=
_
0.5
0.1
_
1. Construct the isoquant for = 1.
2. Assuming constant returns to scale, construct the isoquant for = 2.
3. If the technique z
4
= [0.25, 0.5] were also available would it be included in
the isoquant for = 1?
Outline Answer
q = 1
z
1
z
2
0
0.2
0.5
0.3
0.2
0.5
0.1
z
1
z
2
z
3
z
4
Figure 2.1: Isoquant simple case
3
Microeconomics CHAPTER 2. THE FIRM
0
0.2
0.5
q = 1
z
2
z
3
0.3
0.2
z
4
z
1
z
1
z
2
0.5
0.1

Figure 2.2: Isoquant alternative case
0
0.2
0.5
q = 1
z
2
z
3
0.3
0.2
q = 2
z
1
z
1
z
2
0.5
0.1

Figure 2.3: Isoquants under CRTS

c _Frank Cowell 2006 4
Microeconomics
1. See Figure 2.1 for the simplest case. However, if other basic techniques
are also available then an isoquant such as that in Figure 2.2 is consistent
with the data in the question.
2. See Figure 2.3. Draw the rays through the origin that pass through each
of the corners of the isoquant for = 1. Each corner of the isoquant for
= 2. lies twice as far out along the ray as the corner for the case = 1.
3. Clearly z
4
should not be included in the isoquant since z
4
requires strictly
more of either input to produce one unit of output than does z
2
so that it
cannot be ecient. This is true whatever the exact shape of the isoquant
in see Figures 2.1 and 2.2
Exercise 2.2 A rm uses two inputs in the production of a single good. The
input requirements per unit of output for a number of alternative techniques are
given by the following table:
Process 1 2 3 4 5 6
Input 1 9 15 7 1 3 4
Input 2 4 2 6 10 9 7
The rm has exactly 140 units of input 1 and 410 units of input 2 at its disposal.
1. Discuss the concepts of technological and economic eciency with refer-
ence to this example.
2. Describe the optimal production plan for the rm.
3. Would the rm prefer 10 extra units of input 1 or 20 extra units of input
2?
Outline Answer
1. As illustrated in gure 2.4 only processes 1,2,4 and 6 are technically e-
cient.
2. Given the resource constraint (see shaded area), the economically ecient
input combination is a mixture of processes 4 and 6.
5
3
0
z
1
z
2
.
Economically Efficient
Point
Attainable
Set
4
6
1
2
Figure 2.4: Economically ecient point
3. Note that in the neighbourhood of this ecient point MRTS=1. So, as
illustrated in the enlarged diagram in Figure 2.5, 20 extra units of input
2 clearly enable more output to be produced than 10 extra units of input
1.
Microeconomics
Original
Isoquant
20
10
Figure 2.5: Eect of increase in input
Exercise 2.3 Consider the following structure of the cost function: C(w, 0) =
0, C
j
(w, ) = int() where int(r) is the smallest integer greater than or equal to
r. Sketch total, average and marginal cost curves.
Outline Answer
From the question the cost function is given by
C(w, ) = / / + 1, / 1 < _ /, / = 1, 2, 3...
so that average cost is
/ +
1 /
, / 1 < _ /, / = 1, 2, 3...
see Figure 2.6.
0
q
1 2 3
C(w,q)
C
q
(w,q)
C(w,q)/q
Figure 2.6: Stepwise marginal cost
Microeconomics
Exercise 2.4 Suppose a rms production function has the Cobb-Douglas form
= .
o
1
1
.
o
2
2
where .
1
and .
2
are inputs, is output and c
1
, c
2
are positive parameters.
1. Draw the isoquants. Do they touch the axes?
2. What is the elasticity of substitution in this case?
3. Using the Lagrangean method nd the cost-minimising values of the inputs
and the cost function.
4. Under what circumstances will the production function exhibit (a) decreas-
ing (b) constant (c) increasing returns to scale? Explain this using rst
the production function and then the cost function.
5. Find the conditional demand curve for input 1.
z
2
z
1
Figure 2.7: Isoquants: Cobb-Douglas
Outline Answer
1. The isoquants are illustrated in Figure 2.7. They do not touch the axes.
2. The elasticity of substitution is dened as
o
I
:=
0 log (.
,.
I
)
0 log
_
c
(z),c
I
(z)
_
which, in the two input case, becomes
o =
0 log
_
:
1
:
2
_
0 log
_
1
(z)
2
(z)
_ (2.1)
In case 1 we have c(z) = .
o
1
1
.
o
2
2
and so, by dierentiation, we nd:
c
1
(z)
c
2
(z)
=
c
1
c
2
,
.
1
.
2
Taking logarithms we have
log
_
.
1
.
2
_
= log
_
c
1
c
2
_
log
_
c
1
(z)
c
2
(z)
_
or
n = log
_
c
1
c
2
_
where n := log (.
1
,.
2
) and := log (c
1
,c
2
). Dierentiating n with respect
to we have
0n
0
= 1. (2.2)
So, using the denitions of n and in equation (2.2) we have
o =
0n
0
= 1.
3. This is a Cobb-Douglas production function. This will yield a unique inte-
rior solution; the Lagrangean is:
/(z, `) = n
1
.
1
+n
2
.
2
+`[ .
o
1
1
.
o
2
2
] , (2.3)
and the rst-order conditions are:
0/(z, `)
0.
1
= n
1
`c
1
.
o
1
1
1
.
o
2
2
= 0 , (2.4)
0/(z, `)
0.
2
= n
2
`c
2
.
o
1
1
.
o
2
1
2
= 0 , (2.5)
0/(z, `)
0`
= .
o
1
1
.
o
2
2
= 0 . (2.6)
Using these conditions and rearranging we can get an expression for min-
imized cost in terms of and :
n
1
.
1
+n
2
.
2
= `c
1
.
o
1
1
.
o
2
2
+`c
2
.
o
1
1
.
o
2
2
= [c
1
+c
2
] `.
We can then eliminate `:
n
1
`c
1
j
:
1
= 0
n
2
`c
2
j
:
2
= 0
_
which implies
.
1
=
o
1
u
1
`
.
2
=
o
2
u
2
`
_
. (2.7)
Substituting the values of .
1
and .
2
back in the production function we
have
_
c
1
n
1
`
_
o
1
_
c
2
n
2
`
_
o
2
=
Microeconomics
which implies
` =
_
_
n
1
c
1
_
o
1
_
n
2
c
2
_
o
2
_
1
1
+
2
(2.8)
So, using (2.7) and (2.8), the corresponding cost function is
C(w, ) = n
1
.
1
+n
2
.
2
= [c
1
+c
2
]
_
_
n
1
c
1
_
o
1
_
n
2
c
2
_
o
2
_
1
1
+
2
.
4. Using the production functions we have, for any t 0:
c(tz) = [t.
1
]
o
1
[t.
2
]
o
2
= t
o
1
+o
2
c(z).
Therefore we have DRTS/CRTS/IRTS according as c
1
+ c
2
S 1. If
we look at average cost as a function of we nd that AC is increas-
ing/constant/decreasing in according as c
1
+c
2
S 1.
5. Using (2.7) and (2.8) conditional demand functions are
H
1
(w, ) =
_
_
c
1
n
2
c
2
n
1
_
o
2
_
1
1
+
2
H
2
(w, ) =
_
_
c
2
n
1
c
1
n
2
_
o
1
_
1
1
+
2
and are smooth with respect to input prices.
Exercise 2.5 Suppose a rms production function has the Leontief form
= min
_
.
1
c
1
,
.
2
c
2
_
where the notation is the same as in Exercise 2.4.
1. Draw the isoquants.
2. For a given level of output identify the cost-minimising input combina-
tion(s) on the diagram.
3. Hence write down the cost function in this case. Why would the La-
grangean method of Exercise 2.4 be inappropriate here?
4. What is the conditional input demand curve for input 1?
5. Repeat parts 1-4 for each of the two production functions
= c
1
.
1
+c
2
.
2
= c
1
.
2
1
+c
2
.
2
2
Explain carefully how the solution to the cost-minimisation problem diers
in these two cases.
z
2
z
1
A B
Figure 2.8: Isoquants: Leontief
Outline Answer
1. The Isoquants are illustrated in Figure 2.8 the so-called Leontief case,
2. If all prices are positive, we have a unique cost-minimising solution at A:
to see this, draw any straight line with positive nite slope through A
and take this as an isocost line; if we considered any other point B on the
isoquant through A then an isocost line through B (same slope as the one
through A) must lie above the one you have just drawn.
Microeconomics
z
2
z
1
Figure 2.9: Isoquants: linear
z
2
z
1
Figure 2.10: Isoquants: non-convex to origin
3. The coordinates of the corner A are (c
1
, c
2
) and, given w, this imme-
diately yields the minimised cost.
C(w, ) = n
1
c
1
+n
2
c
2
.
The methods in Exercise 2.4 since the Lagrangean is not dierentiable at
the corner.
4. Conditional demand is constant if all prices are positive
H
1
(w, ) = c
1
H
2
(w, ) = c
2
.
5. Given the linear case
= c
1
.
1
+c
2
.
2
Isoquants are as in Figure 2.9.
It is obvious that the solution will be either at the corner (,c
1
, 0)
if n
1
,n
2
< c
1
,c
2
or at the corner (0, ,c
2
) if n
1
,n
2
c
1
,c
2
, or
otherwise anywhere on the isoquant
This immediately shows us that minimised cost must be.
C(w, ) = min
_
n
1
c
1
,
n
2
c
2
_
So conditional demand can be multivalued:
H
1
(w, ) =
_
_
j
o
1
if
u
1
u
2
<
o
1
o
2
.
1

_
0,
j
o
1
_
if
u
1
u
2
=
o
1
o
2
0 if
u
1
u
2

o
1
o
2
H
2
(w, ) =
_
_
0 if
u
1
u
2
<
o
1
o
2
.
2

_
0,
j
o
2
_
if
u
1
u
2
=
o
1
o
2
j
o
2
if
u
1
u
2

o
1
o
2
Case 3 is a test to see if you are awake: the isoquants are not convex
to the origin: an experiment with a straight-edge to simulate an
isocost line will show that it is almost like case 2 the solution will
be either at the corner (
_
,c
1
, 0) if n
1
,n
2
<
_
c
1
,c
2
or at the
corner (0,
_
,c
2
) if n
1
,n
2

_
c
1
,c
2
(but nowhere else). So the
cost function is :
C(w, ) = min
_
n
1
_

c
1
, n
2
_
,c
2
_
.
Microeconomics
The conditional demand function is similar to, but slightly dierent
from, the previous case:
H
1
(w, ) =
_
_
j
o
1
if
u
1
u
2
<
_
o
1
o
2
.
1

_
0,
j
o
1
_
if
u
1
u
2
=
_
o
1
o
2
0 if
u
1
u
2

_
o
1
o
2
H
2
(w, ) =
_
_
0 if
u
1
u
2
<
_
o
1
o
2
.
2

_
0,
j
o
2
_
if
u
1
u
2
=
_
o
1
o
2
j
o
2
if
u
1
u
2

_
o
1
o
2
Note the discontinuity exactly at n
1
,n
2
=
_
c
1
,c
2
Exercise 2.6 Assume the production function
c(z) =
_
c
1
.
o
1
+c
2
.
o
2
_ 1
where .
I
is the quantity of input i and c
I
_ 0 , < , _ 1 are parameters.
This is an example of the CES (Constant Elasticity of Substitution) production
function.
1. Show that the elasticity of substitution is
1
1o
.
2. Explain what happens to the form of the production function and the elas-
ticity of substitution in each of the following three cases: , , , 0,
, 1.
3. Relate your answer to the answers to Exercises 2.4 and 2.5.
Outline Answer
1. Writing the production function as
c(z) :=
_
c
1
.
o
1
+c
2
.
o
2
_ 1
it is clear that the marginal product of input i is.

c
I
(z) :=
_
c
1
.
o
1
+c
2
.
o
2
_ 1
1
c
I
.
o1
I
(2.9)
Therefore the MRTS is
c
1
(z)
c
2
(z)
=
c
1
c
2
_
.
1
.
2
_
o1
(2.10)
which implies
log
_
.
1
.
2
_
=
1
1 ,
log
c
1
c
2

1
1 ,
log
_
c
1
(z)
c
2
(z)
_
.
Therefore
o =
0 log
_
:
1
:
2
_
0 log
_
1
(z)
2
(z)
_ =
1
1 ,
2. Clearly , yields o = 0 (c(.) = minc
1
.
1
, c
2
.
2
), , 0 yields
o = 1 (c(.) = .
o
1
1
.
o
2
2
), , 1 yields o = (c(.) = c
1
.
1
+c
2
.
2
).
3. The case , corresponds to that in part 1 of Exercise 2.5; , 0.
corresponds to that in Exercise 2.4; , 1. corresponds to that in part 5
of Exercise 2.5 .
Microeconomics
Exercise 2.7 For the CES function in Exercise 2.6 nd H
1
(w, ), the condi-
tional demand for good 1, for the case where , ,= 0, 1. Verify that it is decreasing
in n
1
and homogeneous of degree 0 in (n
1
,n
2
).
Outline Answer
From the minimization of the following Lagrangean
/(z, `; w, ) :=
n
I=1
n
I
.
I
+`[ c(z)]
we obtain
`
c
1
[.
1
]
o1
1o
= n
1
(2.11)
`
c
2
[.
2
]
o1
1o
= n
2
(2.12)
On rearranging:
n
1
c
1
1
`
1o
= [.
1
]
o1
n
2
c
2
1
`
1o
= [.
2
]
o1
Using the production function we get
c
1
_
n
1
c
1
1
`
1o
_

1
+c
2
_
n
2
c
2
1
`
1o
_

1
=
o
Rearranging we nd
`
1o
=
_
c
1
1
1
[n
1
]

1
+c
1
1
2
[n
2
]

1
_
1
1o
Substituting this into (2.11) we get:
n
1
= c
1
[.
1
]
o1
_
c
1
1
1
[n
1
]

1
+c
1
1
2
[n
2
]

1
_
1
1o
Rearranging this we have:
.
1
=
_
c
1
+c
2
_
c
1
c
2
n
2
n
1
_

1
_
1
Clearly .
1
is decreasing in n
1
if , < 1. Furthermore, rescaling n
1
and n
2
by some positive constant will leave .
1
unchanged.
Exercise 2.8 For any homothetic production function show that the cost func-
tion must be expressible in the form
C (w, ) = a (w) / () .
0
z
2
z
1
Figure 2.11: Homotheticity: expansion path
Outline Answer
From the denition of homotheticity, the isoquants must look like Figure
2.11; interpreting the tangents as isocost lines it is clear from the gure that
the expansion paths are rays through the origin. So, if H
I
(w, ) is the demand
for input i conditional on output , the optimal input ratio
H
I
(w, )
H
(w, )
must be independent of and so we must have
H
I
(w, )
H
I
(w,
0
)
=
H
(w, )
H
(w,
0
)
for any ,
0
. For this to true it is clear that the ratio H
I
(w, ),H
I
(w,
0
) must
be independent of w. Setting
0
= 1 we therefore have
H
1
(w, )
H
1
(w, 1)
=
H
2
(w, )
H
2
(w, 1)
= ... =
H
n
(w, )
H
n
(w, 1)
= /()
and so
H
I
(w, ) = /()H
I
(w, 1).
Microeconomics
Therefore the minimized cost is given by
C(w, ) =
n
I=1
n
I
H
I
(w, )
=
n
I=1
n
I
/()H
I
(w, 1)
= /()
n
I=1
n
I
H
I
(w, 1)
= a(w)/()
where a(w) =
n
I=1
n
I
H
I
(w, 1).
Exercise 2.9 Consider the production function
=
_
c
1
.
1
1
+c
2
.
1
2
+c
3
.
1
3
1
1. Find the long-run cost function and sketch the long-run and short-run
marginal and average cost curves and comment on their form.
2. Suppose input 3 is xed in the short run. Repeat the analysis for the
short-run case.
3. What is the elasticity of supply in the short and the long run?
Outline Answer
1. The production function is clearly homogeneous of degree 1 in all inputs
i.e. in the long run we have constant returns to scale. But CRTS implies
constant average cost. So
LRMC = LRAC = constant
Their graphs will be an identical straight line.
z
2
z
1
Figure 2.12: Isoquants do not touch the axes
2. In the short run .
3
= .
3
so we can write the problem as the following
Lagrangean
^
/(z,
^
`) = n
1
.
1
+n
2
.
2
+
^
`
_

_
c
1
.
1
1
+c
2
.
1
2
+c
3
.
1
3
1
_
; (2.13)
or, using a transformation of the constraint to make the manipulation
easier, we can use the Lagrangean
/(z, `) = n
1
.
1
+n
2
.
2
+`
_
c
1
.
1
1
+c
2
.
1
2
/
(2.14)
where ` is the Lagrange multiplier for the transformed constraint and
/ :=
1
c
3
.
1
3
. (2.15)
Microeconomics
Note that the isoquant is
.
2
=
c
2
/ c
1
.
1
1
.
From the Figure 2.12 it is clear that the isoquants do not touch the axes
and so we will have an interior solution. The rst-order conditions are
n
I
`c
I
.
2
I
= 0, i = 1, 2 (2.16)
which imply
.
I
=
_
`c
I
n
I
, i = 1, 2 (2.17)
To nd the conditional demand function we need to solve for `. Using the
production function and equations (2.15), (2.17) we get
/ =
2
=1
c
_
`c
_
1/2
(2.18)
from which we nd
_
` =
/
/
(2.19)
where
/ :=
_
c
1
n
1
+
_
c
2
n
2
.
Substituting from (2.19) into (2.17) we get minimised cost as
~
C (w, ; .
3
) =
2
I=1
n
I
.
I
+n
3
.
3
(2.20)
=
/
2
/
+n
3
.
3
(2.21)
=
/
2
1 c
3
.
1
3

+n
3
.
3
. (2.22)
Marginal cost is
/
2
_
1 c
3
.
1
3

2
(2.23)
and average cost is
/
2
1 c
3
.
1
3

+
n
3
.
3
. (2.24)
Let be the value of for which MC=AC in (2.23) and (2.24) at the
minimum of AC in Figure 2.13 and let 1 be the corresponding minimum
value of AC. Then, using j =MC in (2.23) for j _j the short-run supply
curve is given by
= o(w, j) =
_
_
0 if j <j
0 or if j =j
=
:
3
o
3
_
1
b
p
_
if j j
3. Dierentiating the last line in the previous formula we get
d ln
d lnj
=
j
d
dj
=
1
2
1
_
j,/ 1
0
Note that the elasticity decreases with /. In the long run the supply curve
coincides with the MC,AC curves and so has innite elasticity.
marginal
cost
average
cost
q
Figure 2.13: Short-run marginal and average cost
Microeconomics
Exercise 2.10 A competitive rms output is determined by
= .
o
1
1
.
o
2
2
....
o
m
n
where .
I
is its usage of input i and c
I
0 is a parameter i = 1, 2, ..., :. Assume
that in the short run only / of the : inputs are variable.
1. Find the long-run average and marginal cost functions for this rm. Under
what conditions will marginal cost rise with output?
2. Find the short-run marginal cost function.
3. Find the rms short-run elasticity of supply. What would happen to this
elasticity if / were reduced?
Outline Answer
Write the production function in the equivalent form:
log =
n
I=1
c
I
log .
I
(2.25)
The isoquant for the case : = 2 would take the form
.
2
=
_
.
o
1
1
1
2
(2.26)
which does not touch the axis for nite (.
1
, .
2
).
1. The cost-minimisation problem can be represented as minimising the La-
grangean
n
I=1
n
I
.
I
+`
_
log
n
I=1
c
I
log .
I
_
(2.27)
where n
I
is the given price of input i, and ` is the Lagrange multiplier
for the modied production constraint. Given that the isoquant does not
touch the axis we must have an interior solution: rst-order conditions are
n
I
`c
I
.
1
I
= 0, i = 1, 2, .., : (2.28)
which imply
.
I
=
`c
I
n
I
, i = 1, 2, .., : (2.29)
Now solve for `. Using (2.25) and (2.29) we get
.
o
i
I
=
_
`c
I
n
I
_
o
i
, i = 1, 2, .., : (2.30)
=
n
I=1
.
o
i
I
=
_
`
_
~ n
I=1
n
o
i
I
(2.31)
where :=

n
=1
c
and := [
n
I=1
c
o
i
I
]
1/~
are constants, from which
we nd
` =
_

n
I=1
n
o
i
I
_
1/~
= [n
o
1
1
n
o
2
2
...n
o
m
n
]
1/~
. (2.32)
Substituting from (2.32) into (2.29) we get the conditional demand func-
tion:
H
I
(w, ) = .
I
=
c
I
n
I
[n
o
1
1
n
o
2
2
...n
o
m
n
]
1/~
(2.33)
and minimised cost is
C (w, ) =
n
I=1
n
I
.
I
= [n
o
1
1
n
o
2
2
...n
o
m
n
]
1/~
(2.34)
= 1
1/~
(2.35)
where 1 := [n
o
1
1
n
o
2
2
...n
o
m
n
]
1/~
. It is clear from (2.35) that cost is
increasing in and increasing in n
I
if c
I
0 (it is always nondecreasing
in n
I
). Dierentiating (2.35) with respect to marginal cost is
C
j
(w, ) = 1
1
(2.36)
Clearly marginal cost falls/stays constant/rises with as T 1.
2. In the short run inputs 1, ..., / (/ _ :) remain variable and the remaining
inputs are xed. In the short-run the production function can be written
as
log =
|
I=1
c
I
log .
I
+ log 0
|
(2.37)
where
0
|
:= exp
_
n
I=|+1
c
I
log .
I
_
(2.38)
and .
I
is the arbitrary value at which input i is xed; note that 1 is
xed in the short run. The general form of the Lagrangean (2.27) remains
unchanged, but with replaced by ,0
|
and : replaced by /. So the
rst-order conditions and their corollaries (2.28)-(2.32) are essentially as
before, but and are replaced by
|
:=
|
=1
c
(2.39)
and
|
:=
_
|
I=1
c
o
i
I
_
1/~
k
. Hence short-run conditional demand is
~
H
I
(w, ; .
|+1
, ..., .
n
) =
c
I
n
I
|
_

0
|
n
o
1
1
n
o
2
2
...n
o
k
|
_
1/~
k
(2.40)
Microeconomics
and minimised cost in the short run is
~
C (w, ; .
|+1
, ..., .
n
) =
|
I=1
n
I
.
I
+c
|
=
|
|
_

0
|
n
o
1
1
n
o
2
2
...n
o
k
|
_
1/~
k
+c
|
(2.41)
=
|
1
|
1/~
k
+c
|
(2.42)
where
c
|
:=
n
I=|+1
n
I
.
I
(2.43)
is the xed-cost component in the short run and 1
|
:=
|
[n
o
1
1
n
o
2
2
...n
o
k
|
,0
|
]
1/~
k
.
Dierentiating (2.42) we nd that short-run marginal cost is
~
C
j
(w, ; .
|+1
, ..., .
n
) = 1
|
1
k
k
3. Using the Marginal cost=price condition we nd
1
|
1
k
k
= j (2.44)
where j is the price of output so that, rearranging (2.44) the supply func-
tion is
= o (w, j; .
|+1
, ..., .
n
) =
_
j
1
|
_

k
1
k
(2.45)
wherever MC_AC. The elasticity of (2.45) is given by
0 log o (w, j; .
|+1
, ..., .
n
)
0 log j
=

|
1
|
0 (2.46)
It is clear from (2.39) that
|
_
|1
_
|2
... and so the positive supply
elasticity in (2.46) must fall as / falls.
Exercise 2.11 A rm produces goods 1 and 2 using goods 3,...,5 as inputs. The
production of one unit of good i (i = 1, 2) requires at least a
I
units of good ,, (
, = 3, 4, 5).
1. Assuming constant returns to scale, how much of resource , will be needed
to produce
1
units of commodity 1?
2. For given values of
3
,
4
,
5
sketch the set of technologically feasible out-
puts of goods 1 and 2.
Outline Answer
1. To produce
1
units of commodity 1 a
1
1
units of resource , will be
needed.
1
a
1I
+
2
a
2I
_ 1
I
.
2. The feasibility constraint for resource , is therefore going to be
1
a
1
+
2
a
2
_ 1
.
Taking into account all three resources, the feasible set is given as in Figure
2.14
q
1
q
2
Feasible
Set
points satisfying
q
1
a
13
+ q
2
a
23
R
3
points satisfying
q
1
a
13
+ q
2
a
23
R
3
points satisfying
q
1
a
14
+ q
2
a
24
R
4
points satisfying
q
1
a
14
+ q
2
a
24
R
4
points satisfying
q
1
a
15
+ q
2
a
25
R
5
points satisfying
q
1
a
15
+ q
2
a
25
R
5
Figure 2.14: Feasible set
Exercise 2.12 [see Exercise 2.4]
Microeconomics
Exercise 2.13 An agricultural producer raises sheep to produce wool (good 1)
and meat (good 2). There is a choice of four breeds (A, B, C, D) that can be
used to stock the farm; each breed can be considered as a separate input to the
production process. The yield of wool and of meat per 1000 sheep (in arbitrary
units) for each breed is given in Table 2.1.
A B C D
wool 20 65 85 90
meat 70 50 20 10
Table 2.1: Yield per 1000 sheep for breeds A,...,D
1. On a diagram show the production possibilities if the producer stocks ex-
actly 1000 sheep using just one breed from the set {A,B,C,D} .
2. Using this diagram show the production possibilities if the producers 1000
sheep are a mixture of breeds A and B. Do the same for a mixture of
breeds B and C; and again for a mixture of breeds C and D. Hence draw
the (wool, meat) transformation curve for 1000 sheep. What would be the
transformation curve for 2000 sheep?
3. What is the MRT of meat into wool if a combination of breeds A and B are
used? What is the MRT if a combination of breeds B and C are used?And
if breeds C and D are used?
4. Why will the producer not nd it necessary to use more than two breeds?
5. A new breed E becomes available that has a (wool, meat) yield per 1000
sheep of (50,50). Explain why the producer would never be interested in
stocking breed E if breeds A,...,D are still available and why the transfor-
mation curve remains unaected.
6. Another new breed F becomes available that has a (wool, meat) yield per
1000 sheep of (50,50). Explain how this will alter the transformation
curve.
Outline Answer
1. See Figure 2.15.
2. See Figure 2.15.
3. The MRT if and 1 are used is
70 50
20 65
=
4
9
. If 1 and C are used it
is going to be
20 50
85 65
=
3
2
.
4. In general for : inputs and : outputs if : : then : : inputs are
redundant.
5. As we can observe in Figure 2.15, by using breed 1 the producer cannot
move the frontier (the transformation curve) outwards.
0
20
40
60
80
0 20 40 60 80 100
wool
m
e
a
t
0
20
40
60
80
0 20 40 60 80 100
wool
m
e
a
t
Figure 2.15: The wool and meat tradeo
6. As we can observe in Figure 2.16 now the technological frontier has moved
outwards: one of the former techniques is no longer on the frontier.
0
20
40
60
80
0 20 40 60 80 100
wool
m
e
a
t
0
20
40
60
80
0 20 40 60 80 100
wool
m
e
a
t
Figure 2.16: Eect of a new breed
Microeconomics
Exercise 2.14 A rm produces goods 1 and 2 uses labour (good 3) as input
subject to the production constraint
[
1
]
2
+ [
2
]
2
+
3
_ 0
where
I
is net output of good i and is a positive constant. Draw the trans-
formation curve for goods 1 and 2. What would happen to this transformation
curve if the constant had a larger value?
Outline Answer
1. From the production function it is clear that, for any given value
3
,
the transformation curve is the boundary of the the set of points (
1
,
2
)
satisfying
[
1
]
2
+ [
2
]
2
_
3
1
,
2
_ 0
where the right-hand side of the rst expression is positive because
3
is
negative. This is therefore going to be a quarter circle as in Figure 2.17.
2. See Figure 2.17.
q
2
q
1
Small A
Large A
Figure 2.17: Transformation curves

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Chapter 2

Figure 2.3: Isoquants under CRTS

it is clear that the marginal product of input i is.

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