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Cost Minimization
Ch 3-4 Hal R Varian

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Cost minimization

Exercises of Microeconomics

Fabio Tramontana (University of Pavia)

slides available at: http://tramontana.altervista.org/teaching.html

Tramontana

Exercises Micro

Prot Function

Cost minimization

Outline

1

Prot Function

Exercise 3.1

Exercise 3.2

Exercise 3.3

Exercise 3.4

Exercise 3.5

Cost minimization

Exercise 4.3

Exercise 4.4

Exercise 4.6

Exercise 4.7

Exercise 4.8

Tramontana

Exercises Micro

Prot Function

Cost minimization

Exercise

Exercise

Exercise

Exercise

Exercise

3.1

3.2

3.3

3.4

3.5

Outline

1

Prot Function

Exercise 3.1

Exercise 3.2

Exercise 3.3

Exercise 3.4

Exercise 3.5

Cost minimization

Exercise 4.3

Exercise 4.4

Exercise 4.6

Exercise 4.7

Exercise 4.8

Tramontana

Exercises Micro

Prot Function

Cost minimization

Exercise

Exercise

Exercise

Exercise

Exercise

3.1

3.2

3.3

3.4

3.5

(w , w ) = (w ) + (w ). The price of the output is normalized

to be 1.

(a) What do we know about the rst and second derivatives of the

functions (w )?

1

prices and convex, so:

i0 (wi ) 0

and

Tramontana

i00 (wi ) 0 .

Exercises Micro

Prot Function

Cost minimization

Exercise

Exercise

Exercise

Exercise

Exercise

3.1

3.2

3.3

3.4

3.5

the sign of x / w ?

i

additive form, one factor does not inuence the optimum value of

the other, so:

xi / wj = 0.

Tramontana

Exercises Micro

Prot Function

Cost minimization

Exercise

Exercise

Exercise

Exercise

Exercise

3.1

3.2

3.3

3.4

3.5

prot function of this form. What can we say about the form of

this production function? (Hint: look at the rst order conditions.)

1

We have seen that the demand for a factor only depends on its

price. So, the marginal product of each factor must only be a

function of the amount of the factor itself. It follows that:

f (x , x

1

) = g1 (x1 ) + g2 (x2 ).

Tramontana

Exercises Micro

Prot Function

Cost minimization

Exercise

Exercise

Exercise

Exercise

Exercise

3.1

3.2

3.3

3.4

3.5

Outline

1

Prot Function

Exercise 3.1

Exercise 3.2

Exercise 3.3

Exercise 3.4

Exercise 3.5

Cost minimization

Exercise 4.3

Exercise 4.4

Exercise 4.6

Exercise 4.7

Exercise 4.8

Tramontana

Exercises Micro

Prot Function

Cost minimization

Exercise

Exercise

Exercise

Exercise

Exercise

3.1

3.2

3.3

3.4

3.5

Exercise 3.2

for x > 1. Calculate the prot function for this technology.

Note that we are looking for an expression in which prots does

only depend on prices:

(p , w )

function y (p , w ).

Tramontana

Exercises Micro

Prot Function

Cost minimization

Exercise

Exercise

Exercise

Exercise

Exercise

3.1

3.2

3.3

3.4

3.5

Solution

Demand function and supply function come from the rst order

condition:

from which we have that:

p /x = w ,

that gives us the prot function:

(p , w ) = py (p , w ) wx (p , w ) = p ln(p /w ) p

but given that the rm may always choice x = 0 to avoid negative

prots, we have:

(p , w ) = max {p ln(p /w ) p , 0} .

Tramontana

Exercises Micro

Prot Function

Cost minimization

Exercise

Exercise

Exercise

Exercise

Exercise

3.1

3.2

3.3

3.4

3.5

Outline

1

Exercise 3.1

Exercise 3.2

Exercise 3.3

Exercise 3.4

Exercise 3.5

Cost minimization

Exercise 4.3

Exercise 4.4

Exercise 4.6

Exercise 4.7

Exercise 4.8

Tramontana

Exercises Micro

Exercise

Exercise

Exercise

Exercise

Exercise

Prot Function

Cost minimization

3.1

3.2

3.3

3.4

3.5

Exercise 3.3

calculate the prot-maximizing demand and supply functions, and

the prot function. For simplicity assume an interior solution.

Assume that a > 0.

1

price, we have the following rst-order conditions:

1

p

w

x

p

a w

x

a

=0

=0

Tramontana

Exercises Micro

Exercise

Exercise

Exercise

Exercise

Exercise

Prot Function

Cost minimization

3.1

3.2

3.3

3.4

3.5

Solution

We have:

p

w

p

x =a

w

x

= a1

p

(p , w , w ) = p a ln a

w

"

Tramontana

p

+ a ln a

w

2

Exercises Micro

a1 a2

Prot Function

Cost minimization

Exercise

Exercise

Exercise

Exercise

Exercise

3.1

3.2

3.3

3.4

3.5

Outline

1

Exercise 3.1

Exercise 3.2

Exercise 3.3

Exercise 3.4

Exercise 3.5

Cost minimization

Exercise 4.3

Exercise 4.4

Exercise 4.6

Exercise 4.7

Exercise 4.8

Tramontana

Exercises Micro

Exercise

Exercise

Exercise

Exercise

Exercise

Prot Function

Cost minimization

3.1

3.2

3.3

3.4

3.5

Exercise 3.4

prot maximizing demand and supply functions, and the prot

function. Assume a > 0. What restrictions must a and a satisy?

1

pa x

pa x

1

a1

1

a2

1

1

x

x

2

2

2

1

w1 = 0

w2 = 0

Tramontana

Exercises Micro

Exercise

Exercise

Exercise

Exercise

Exercise

Prot Function

Cost minimization

3.1

3.2

3.3

3.4

3.5

Solution

w

pa

2 =

! a1

1a1

a2

pa

w

pa

! a1

a2 1

1a1

a2

w2 = 0

the rst factor:

Tramontana

Exercises Micro

Exercise

Exercise

Exercise

Exercise

Exercise

Prot Function

Cost minimization

3.1

3.2

3.3

3.4

3.5

Solution

w

pa

2

a2

w

pa

a2

1 +a2 1

!a

goods), we must have:

a +a < 1

1

The other input demand function and the prot function are now

easily obtainable.

Tramontana

Exercises Micro

Prot Function

Cost minimization

Exercise

Exercise

Exercise

Exercise

Exercise

3.1

3.2

3.3

3.4

3.5

Outline

1

Exercise 3.1

Exercise 3.2

Exercise 3.3

Exercise 3.4

Exercise 3.5

Cost minimization

Exercise 4.3

Exercise 4.4

Exercise 4.6

Exercise 4.7

Exercise 4.8

Tramontana

Exercises Micro

Exercise

Exercise

Exercise

Exercise

Exercise

Prot Function

Cost minimization

3.1

3.2

3.3

3.4

3.5

Exercise 3.5

the prot maximizing demand and supply functions, and the prot

function. What restrictions must a satisy?

a

The important note to start the exercise is that the rm will never

use dierent amounts of inputs to produce a certain level of output.

In fact, if not the rm may reduce the amount of the input that is

more used and still produce the same level of output. So we can

assume that:

= x2

f (x , x

1

Tramontana

) = x1a

Exercises Micro

Exercise

Exercise

Exercise

Exercise

Exercise

Prot Function

Cost minimization

3.1

3.2

3.3

3.4

3.5

Solution

px

a

1

w1 x1 w2 x2

pax

(w 1 + w 2 ) = 0

+ w2

(a1)

pa

Supply and prot functions come out easily.

Tramontana

Exercises Micro

Prot Function

Cost minimization

Exercise

Exercise

Exercise

Exercise

Exercise

4.3

4.4

4.6

4.7

4.8

Outline

1

Exercise 3.1

Exercise 3.2

Exercise 3.3

Exercise 3.4

Exercise 3.5

Cost minimization

Exercise 4.3

Exercise 4.4

Exercise 4.6

Exercise 4.7

Exercise 4.8

Tramontana

Exercises Micro

Prot Function

Cost minimization

Exercise

Exercise

Exercise

Exercise

Exercise

4.3

4.4

4.6

4.7

4.8

Exercise 4.3

c (y ) = y . What is the cost function for the rm?

1

2

1

The right way to calculate how much the rm should produce with

each plant, consists in equating the marginal costs, obtaining:

=1

which means that if the rm is producing one unit of output with

the rst plant, it is indierent to produce a little bit more with one

plant or the other one.

Tramontana

Exercises Micro

Prot Function

Cost minimization

Exercise

Exercise

Exercise

Exercise

Exercise

4.3

4.4

4.6

4.7

4.8

Solution

Note that the marginal costs of the second plant are xed and equal

to 1, while the marginal costs of the rst plant are lower (resp.

higher) than 1 if the production is lower (resp. higher) than 1.

Putting together these facts you have the cost function:

y /2

if y < 1

y 1/2 if y > 1 ,

where y 1/2 is obtained considering y = y + y that is

y = y y = y 1.

c (y ) =

Tramontana

Exercises Micro

Prot Function

Cost minimization

Exercise

Exercise

Exercise

Exercise

Exercise

4.3

4.4

4.6

4.7

4.8

Outline

1

Exercise 3.1

Exercise 3.2

Exercise 3.3

Exercise 3.4

Exercise 3.5

Cost minimization

Exercise 4.3

Exercise 4.4

Exercise 4.6

Exercise 4.7

Exercise 4.8

Tramontana

Exercises Micro

Exercise

Exercise

Exercise

Exercise

Exercise

Prot Function

Cost minimization

4.3

4.4

4.6

4.7

4.8

Exercise 4.4

A rm has two plants. One plant produces output according to the

production function x x . The other plant has a production

function x x . What is the cost function for this technology?

a

1

b

1

proceed similarly.

The cost minimization problem for the rst plant is the following:

c (w , y ) = min

w x +w x

1, 2

such that x x = y

x

Tramontana

a

1

Exercises Micro

Exercise

Exercise

Exercise

Exercise

Exercise

Prot Function

Cost minimization

4.3

4.4

4.6

4.7

4.8

Solution

minimization problem as follows:

2

minw x + w y 1a x

1

x1

a

1

a

w y 1a x 1a = 0

1a

that permit us to obtain the conditional demand for factor 1:

1

x (w , w , y ) =

1

Tramontana

a w

1a w

1a

Exercises Micro

Exercise

Exercise

Exercise

Exercise

Exercise

Prot Function

Cost minimization

4.3

4.4

4.6

4.7

4.8

Solution

x (w , w , y ) =

2

a w

1a w

a

c (w , w , y )

1

1a

a a 1a

+ 1a a

= 1a a

w1 w2 y

mutatis mutandis for the second plant we have

c (y ) = B (b, w , w )y .

1

Tramontana

Exercises Micro

Prot Function

Cost minimization

Exercise

Exercise

Exercise

Exercise

Exercise

4.3

4.4

4.6

4.7

4.8

Solution

Given that the marginal costs are xed, the rm will always use the

plant with lower marginal costs.

That is:

c (y ) = min {A, B } y .

Tramontana

Exercises Micro

Prot Function

Cost minimization

Exercise

Exercise

Exercise

Exercise

Exercise

4.3

4.4

4.6

4.7

4.8

Outline

1

Exercise 3.1

Exercise 3.2

Exercise 3.3

Exercise 3.4

Exercise 3.5

Cost minimization

Exercise 4.3

Exercise 4.4

Exercise 4.6

Exercise 4.7

Exercise 4.8

Tramontana

Exercises Micro

Exercise

Exercise

Exercise

Exercise

Exercise

Prot Function

Cost minimization

4.3

4.4

4.6

4.7

4.8

Exercise 4.6

c (y ) = 2y . What is its cost of producing an output y ?

1

MC (y

1

) = MC2 (y2 )

4y2 = y1

1

and by using y = y + y :

1

4

5

1

5

Tramontana

Exercises Micro

Prot Function

Cost minimization

Exercise

Exercise

Exercise

Exercise

Exercise

4.3

4.4

4.6

4.7

4.8

Solution

MAXIMUM and not minimum.

In fact, the cost function is concave and not convex. You can also

look at the second-order conditions.

The minimum is a corner solution, that is

The rm will produce all output at the cheaper plant:

c (y ) = 2 y .

Tramontana

Exercises Micro

Prot Function

Cost minimization

Exercise

Exercise

Exercise

Exercise

Exercise

4.3

4.4

4.6

4.7

4.8

Outline

1

Exercise 3.1

Exercise 3.2

Exercise 3.3

Exercise 3.4

Exercise 3.5

Cost minimization

Exercise 4.3

Exercise 4.4

Exercise 4.6

Exercise 4.7

Exercise 4.8

Tramontana

Exercises Micro

Exercise

Exercise

Exercise

Exercise

Exercise

Prot Function

Cost minimization

4.3

4.4

4.6

4.7

4.8

Exercise 4.7

x , x , factor prices w , w , and output y for a rm. Is the behavior

depicted in this table consistent with cost-minimizing behavior?

Obs y w w x x

A 100 2 1 10 20

B 110 1 2 14 10

1

must have that:

The cost of the observed choice of inputs is no greater than the

cost of any any other level of inputs that would produce at least as

much output.

Tramontana

Exercises Micro

Prot Function

Cost minimization

Exercise

Exercise

Exercise

Exercise

Exercise

4.3

4.4

4.6

4.7

4.8

Solution

(10 2 + 20 1) while

to produce 110 units of output it costs 34 (14 1 + 2 10)

The data violate WACM

Tramontana

Exercises Micro

Prot Function

Cost minimization

Exercise

Exercise

Exercise

Exercise

Exercise

4.3

4.4

4.6

4.7

4.8

Outline

1

Exercise 3.1

Exercise 3.2

Exercise 3.3

Exercise 3.4

Exercise 3.5

Cost minimization

Exercise 4.3

Exercise 4.4

Exercise 4.6

Exercise 4.7

Exercise 4.8

Tramontana

Exercises Micro

Exercise

Exercise

Exercise

Exercise

Exercise

Prot Function

Cost minimization

4.3

4.4

4.6

4.7

4.8

Exercise 4.8

production at w = w = 1 is equal to 4, what is y equal to?

1

min x + x

1

s .t . x x

1

=y

min x + y /x

1

Tramontana

Exercises Micro

Exercise

Exercise

Exercise

Exercise

Exercise

Prot Function

Cost minimization

4.3

4.4

4.6

4.7

4.8

Solution

We have that:

y =4=x

+ x2 = 2

and nally:

y =4

Tramontana

Exercises Micro

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