Introduction to Microeconomics Exercise 7 - Production and Cost

These questions are for discussion in tutorials. The tutorials are not intended to simply work through all the answers to these questions. You will be provided with written answers on Blackboard in due course. The tutorials are intended to selectively discuss aspects of these questions that you nd dicult or challenging or wish to explore further. You should come to tutorials having attempted the questions and with suggestions for which questions or parts of questions you would like the tutor to go through in more detail. Chapters 6 and 7 in Perlo will help with this material. If you dont have Perlo, the chapters on production and cost in any of the recommended textbooks will do equally well. 1. Michelles business produces ceramic cups using labour, clay and a kiln. She can produce 25 cups a day with one worker and 35 with two workers. Does her production process illustrate diminishing marginal returns to labour or not? Give some intuition for your result. 2. Suppose the isoquants for a production function look like the following: 5 4 3 K 2 1 0 0 1 2 L (a) Are L and K substitutes for each other? (b) Without calculating it, guess what the elasticity of substitution will be for this production function. (c) Suppose w = 1 and r = 2. Draw isocost lines on the diagram showing the minimum cost way of producing outputs 5, 10 and 15. (d) Hence draw the expansion path. (e) Explain how you would derive the cost function from this expansion path. (f) Can you think of any production processes that might have isoquants like this? 3. Consider the production function q = L + K . (a) Consider multiplying both factors of production by an integer, , thereby increasing the scale of production. For simplicity, you can think of = 2. Show that this function exhibits constant returns to scale. (b) Draw the isoquants for this function and nd the MRTS. What do you think the elasticity of substitution would be here? (c) What is the marginal product of labour? (d) Is this a realistic production function? 1 3 4 5 q = 10 q=5 q = 15

4. Consider the Cobb-Douglas production function: q = K L , where >, > 0. Is it possible for there to be increasing returns to scale and decreasing marginal returns to labour at the same time? 5. Consider a standard isoquant-isocost diagram. Suppose the government subsidises the cost of labour. Show the eect on the optimal capital and labour used in your diagram. What will happen to the expansion path? 6. Consider the cost function C (q ) = 10 + 10q 2 . Plot the AC, AVC, FC and MC for this cost function. Suppose that the wage rate decreases. What would be the eect on your cost curves? 7. Why is the long run average cost never higher than the short run average cost? 8. Technical Changes in Piano Making It takes one year and over 200 production workers to build a Steinway Model D grand piano, which has 12,000 parts. The factory produces 150 of these pianos per year. Steinways technology virtually stopped evolving about 1900. The number of pianos produced per year and the number of workers in the factory has remained constant. They cant use machinery to replace workers, but they can use machinery to aid the workers. Steinway still uses some equipment that was built in the Victorian era, such as a veneer-edge cutter from 1871. Modern equipment is used to rene the tools they use, improve the tolerances of action parts, and make parts that dont need custom tting. A computer-aided router cuts the nal shape of the top lid. A sounder machine breaks the pianos in by pounding every key 8000 times within 45 minutes. An engineer uses CAD/CAM software on a computer to design an action part. Similarly, new materials are used, partly of necessity. Since the ban on the trade of ivory in 1989, keys are now made of a mock-ivory polymer. Cloth bushings that line certain metal pins that serve as hinges in the action are now made of TeonTM-impregnated wool. Yamaha, using a more mechanized approach, makes 250,000 pianos per year, compared to the 523,000 pianos Steinway has produced in 140 years. Yamaha makes ne instruments, but they are not in the class of the Steinway grand piano. (a) Given the information provided, what do you predict about the shape of isoquants for Steinway? (b) The story about production at Steinway is very similar to that of the C. F. Martin Company, makers of some of the worlds nest acoustic guitars. The production of Martin guitars is also characterized by the use of highly skilled labor, limited substitutability between capital and labor, and use of very old machines to perform certain tasks. Why do you suppose that this limited substitutability occurs in the musical instrument industry, when other industries, such as the automobile industry, are characterized by a much greater degree of input substitutability?