Chapter 10 – Applied Problems

1. You are planning to estimate a short-run production function for your firm, and you have collected the
following data on labor usage and output:

Labor Usage Output

3 1
7 2
9 3
11 5
17 8
17 10
20 15
24 18
26 22
28 21
30 23

a. Does a cubic equation appear to be a suitable specification, given these data? You may wish to construct
a scatter diagram to help you answer this question.
To know whether a cubic function can be used as production function the scatter plot can be used. Using
excel sheet draw the scatter plot from the category charts. The scatter for the given data of production
function is given below:

X axis shows the Labor usage and Y axis of the graph shows the output level. The points shows the output
for the corresponding value of labor usage.
The scatter plot is an upward sloping curve with increasing slope. Therefore, a cubic production can be used
to estimate the short run production function.
b. Using a computer and software for regression analysis, estimate your firm’s short-run production
function using the data given here. Do the parameter estimates have the appropriate algebraic signs? Are
they statistically significant at the 5 percent level?
To estimate the cubic function run a regression taking output as dependent variable and taking labor usage,
square of labor usage and cube of labor usage as independent variable. The table showing the value of
dependent and independent variables are given below:

Labor Usage Output L2 L3

3 1 9 27
7 2 49 343
9 3 81 729
11 5 121 1331
17 8 289 4913
17 10 289 4913
20 15 400 8000
24 18 576 13824
26 22 676 17576
28 21 784 21952
30 23 900 27000

Run the regression in excel by following these steps which are given below:
1. Go to options in file and click in Add-Ins and select analysis toolpak from there.
2. Select data from the toolbar and go to data analysis.
3. In data analysis go to regression. The dialogue box appear.
4. In the dialogue box put the value of dependent variable and in next column put the values of independent
variables.
5. Then run the regression. The result for the regression will appear in other sheet of the Excel.
The results are given below:

So the equation for the value of dependent variable in terms of independent variables can be shown as:
Output (Q) = 2.924 – 0.8143L + 0.1044L2 – 0.0018L3
The negative sign of coefficients of labor usage and cube of labor usage doesn’t make sense because it means
that with increase in labor usage the output will fall always which is not a possible case. Even these
coefficients are not significant at 5% significance level as p value is smaller than 0.05. The coefficient of only
square of labor usage is significant.
c. At what point do you estimate marginal product begins to fall?
The marginal product in the short run first increases then become constant and then starts falling. The
marginal product is addition in output due to increase in variable input by one unit. To calculate the lowest
value of labor for which marginal product will have a negative sign differentiate the production function with
respect to L and equate it to zero. The differentiation of short run production function is given below:
Marginal Product = dQ/dL = -0.8143 + 0.2088L – 0.0054L2
The value of marginal product began to fall when the derivative of marginal product with respect to L will be
negative.
The derivative of marginal product is calculated below:

The derivative of marginal product is equated to zero to find the value of L as shown below:

So, after 19 units of labor usage, marginal product of labor will starts falling.
d. Calculate estimates of total, average, and marginal products when the firm employs 23 workers.
The short run production function is given below:
Output (Q) = 2.924 – 0.8143L + 0.1044L2 – 0.0018L3
When L = 23, the value of output can be calculated as shown below:
Output (Q) = 2.924 – 0.8143(23) + 0.1044(23)2 – 0.0018(23)3
The short run marginal product is given below:
Marginal Product = dQ/dL = -0.8143 + 0.2088L – 0.0054L2
When L = 23, the value of marginal product can be calculated as shown below:
Marginal Product = -0.8143 + 0.2088(23) – 0.0054(23)2 = 1.1315
The average product is the quantity of output per unit of worker. The average product can be calculated by
dividing the total output by total number of labor usage. The calculation for average product is shown below:
APL = Q/L = 17.5221/23 = 0.7618
e. When the firm employs 23 workers, is short-run marginal cost (SMC) rising or falling? How can you tell?
To know whether short run MC is rising or falling when firms employ 23 labor units the value of marginal
product should be known. If the value of marginal product at 23 labor units is positive that means marginal
cost is falling due to increasing marginal product. The marginal product is 1.1315 at 23 units of labor.
Therefore, the marginal cost must be decreasing at 23 units of labor usage.
2. Dimex Fabrication Co., a small manufacturer of sheet-metal body parts for a major U.S. automaker,
estimates its long-run production function to be
Q = −0.015625K3L3 + 10K2L2
where Q is the number of body parts produced daily, K is the number of sheet-metal presses in its
manufacturing plant, and L is the number of labor-hours per day of sheet-metal workers employed by
Dimex. Dimex is currently operating with eight sheet-metal presses.
a. What is the total product function for Dimex? The average product function? The marginal product
function?

b. Managers at Dimex can expect the marginal product of additional workers to fall beyond what level of
labor employment?

c. Dimex plans to employ 50 workers. Calculate total product, average product, and marginal product.
3. The chief economist for Argus Corporation, a large appliance manufacturer, estimated the firm’s short-
run cost function for vacuum cleaners using an average variable cost function of the form
AVC = a + bQ + cQ2
where AVC = dollars per vacuum cleaner and Q = number of vacuum cleaners produced each month. Total
fixed cost each month is $180,000. The following results were obtained:
a. Are the estimates â, b̂, and ĉ statistically significant at the 2 percent level of significance?

b. Do the results indicate that the average variable cost curve is ∪-shaped? How do you know?
This is because one coefficient is negative and the other two are positive.
c. If Argus Corporation produces 8,000 vacuum cleaners per month, what is the estimated average variable
cost? Marginal cost? Total variable cost? Total cost?
d. Answer part c, assuming that Argus produces 10,000 vacuum cleaners monthly.

e. At what level of output will average variable cost be at a minimum? What is minimum average variable
cost?