ECON-210 Intermediate Microeconomics Midterm Test No.

2 November 24, 2011 Name Section A: Definitions/Short Answers (4 questions at 5 points each for a total of 20 points) Instruction: Answer each of the following four questions in the space provided. A maximum four sentences should be sufficient. Good penmanship would be appreciated. 1. Carefully define the term production function, and explain its importance. Answer: A firm's production function is a quantitative relationship that indicates the maximum level of output the firm can produce for any combination of inputs. A production function is a guide to management for efficient production of the good or service. Section: 5.1 Basic Production Concepts 2. Carefully explain why the marginal product of labor first rises and then falls as use of labor increases. In which portion of the marginal product of labor curve will the firm typically produce? Answer: The marginal product of labor increases because with more labor, specialization can be exploited. In addition, any underutilized fixed factors can be used more intensively. Marginal product of labor then decreases as opportunities for specialization are exhausted, and more and more labor is applied to a fixed amount of machines and production capacity. The typical firm will produce at an input level for which MPL is falling. SECTION: Production with one variable input 3. Carefully define marginal rate of technical substitution. What assumptions are made in measuring it? Answer: MRTS denotes the rate at which one input substitutes for another in production. When using isoquants, it can be measured as: -MPL/MPK, and it is assumed that Q is constant; that is, we are moving along an isoquant. SECTION: Production in the long run 4. What is minimum efficient scale? Why is it important?

Section B: Essay Questions (4 Questions @ 20 points each for a Total 80 points) Instruction: Answer ALL 4 of the following questions in this section. Explain and detail your answers VERY carefully. The QUALITY of your explanation determines your grade. Please use a separate sheet for each question. Good penmanship would be appreciated. 1. Suppose that a production function can be written Q = 9L2 L3. Making a chart by plugging in values to show the output, marginal product of labor and average product of labor as labor varies from 0 to 9 units or graphing the function Q on the vertical axis and L on the horizontal axis, can you tell for what values of labor is the marginal product of labor rising, constant, falling, and negative? At what value of L does the total product of labor reach a maximum? Answer: By plugging values into this function, we obtain the following figures:
L 0 1 2 3 4 5 6 7 8 9 Q 0 8 28 54 80 100 108 98 64 0 MPL 0 8 20 26 26 20 8 -10 -34 -64 APL 0 8 14 18 20 20 18 14 8 0

Hence, the marginal product is rising over the region [0,3], falling over the region [3,6] and negative for L above 6. This production function reaches a maximum at L = 6. This can be seen from the table. Response: The marginal product of labor is rising as long as the total product is rising. The total product, output, can only fall if the marginal product is falling. In other words, only if additional units of labor destroy output can output fall. Notice that, when the total product is at a maximum, the marginal product must be just constant at zero: if it were

positive, the total product would still be rising, whereas if it were negative, the total product would be falling. The only way for the total product to neither rise nor fall is for the marginal product just to be zero. You can see that this occurs at approximately 6 units from the chart. Section: 6.2 Production Functions with a Single Input 2. a) A firms production function is given by Q = 2K2 + 6L. Does this production function exhibits constant returns to scale? Answer: At K = L = 1, we find that Q = 8. In turn, at K = L = 2, we now have Q = 18 (output more than doubles). Therefore, this production function exhibits increasing returns to scale. b) The average variable cost at Q = 1, Q = 2, Q = 3, Q = 4 is respectively equal to $5, $6, $7, and $8 per unit. Find the marginal cost of the first four units of output. Answer: Q 1 2 3 4 AVC 5 6 7 8 VC 5 12 21 32 MC 5 7 9 11

SECTION: The Costs of Production 3. The firms total cost function is: C = 50 + 6Q + 2Q2. a) Compute the level of output that minimizes average total cost. b) At what level of output does MC = AVC? Answer: a) MC = 6 + 4Q and AC = 50/Q + 6 + 2Q. We know that the point of minimum AC occurs where AC = MC. Therefore, 6 + 4Q = 50/Q + 6 + 2Q, implying 2Q = 50/Q, or Q2 = 25. Thus, QMIN = 5 units.

b) We know that AVC = 6 + 2Q and MC = 6 + 4Q. Equating these implies Q = 0. SECTION: The Costs of Production 4. A firms production process uses labor, L, and capital, K, and materials, M, to produce an output, Q according to the function Q = KLM, where the marginal products of the three inputs are MPL = KM, MPK = LM, and MPM = KL. The wage rate for labor is w = 2, the rental rate of capital is r = 1, and the cost of materials is m = 4 per unit. Let materials input be fixed now at M = 2. What is the cost minimizing level of capital that the firm must use to produce a target level of output, Q = 1600? Answer: 40 Bonus Question (10 points) NOTE: Your final mark for this test cannot exceed 100 points. "The concept of returns to scale is useful in analyzing production but irrelevant in the analysis of consumer behavior." Discuss. Answer: Returns-to-scale refers to how much output increases when all inputs increase by a particular amount. Formally, the returns-to-scale is the percentage increase in output obtained by a given percentage change in all inputs. Returns to scale may be decreasing, constant, or increasing depending on whether a 1% increase in inputs results in a less than, equal, or greater percentage increase in output. Since this concept refers to a change in all inputs used, it is really a long-run description of production. Graphically, if we move from one isoquant to another isoquant corresponding to double the level of all inputs, we want to know whether that isoquant is labeled with a production level that is less than, equal, or greater than the original production level. Since returns to scale vary depending on the absolute amount that output changes as inputs vary, it relies for its meaning on the fact that the production function is cardinal. If we were to define the same concept for consumers, then we would have to impart meaning on numerical increments of utility. This is something that "standard" utility functions do not do.