Professional Documents
Culture Documents
TECHNOLOGY, KUMASI
By
F.T. ODURO & C. SEBIL
DEPARTMENT OF MATHEMATICS, KNUST
OCTOBER, 2011
Contact Address
Dean
Institute of Distance Learning
New Library Building
Kwame Nkrumah University of Science and Technology
Kumasi, Ghana
Phone:
+233-51-60013
+233-51-60014
Fax:
+233-51-60023
+233-51-60014
E-mail:
cdce@fdlknust.edu.gh
kvcit@fdlknust.edu.gh
kvcit@avu.org
Web:
www.fdlknust.edu.gh
ii
Email: francistoduro@yahoo.co.uk
Email: sebicharles@yahoo.com
Course Introduction
This course is designed to present fourth year students of mathematics, actuarial science and
statistics students with the fundamental principles of mathematical economics. It focuses on
basic concepts and uncovers the simplicity and directness of a mathematical approach to
economics theory.
At the end of the course, students are expected to be able to appreciate the constrained
optimizing behaviour of consumers and producers as well as the key structures of the
marketplace.They should also be able to formulate and solve a lot of economic problems in a
mathematical context.
iv
Table of Content
Contact Address .........................................................................................................................ii
About the Author ..................................................................................................................... iii
Course Introduction .................................................................................................................. iv
Table of Content ........................................................................................................................ v
List of Figures ........................................................................................................................... vi
UNIT 1 ....................................................................................................................................... 1
GENERAL CONCEPTS ........................................................................................................... 1
Session 1-1: Introductory Remarks ........................................................................................ 1
Session 2-1: Special Processes............................................. Error! Bookmark not defined.
UNIT 2 ..................................................................................... Error! Bookmark not defined.
GENERAL CONCEPTS ......................................................... Error! Bookmark not defined.
Session 1-2: N-dimensional and Complex Processes .......... Error! Bookmark not defined.
Session 2-2: Stationary Processes ........................................ Error! Bookmark not defined.
UNIT 3 ..................................................................................... Error! Bookmark not defined.
CALCULUS OF STOCHASTIC PROCESSES ...................... Error! Bookmark not defined.
Session 1-3: Stochastic Continuity and Differentiability..... Error! Bookmark not defined.
Session 2-3: Stochastic Differential Equations .................... Error! Bookmark not defined.
UNIT 4 ..................................................................................... Error! Bookmark not defined.
CALCULUS OF STOCHASTIC PROCESSES ...................... Error! Bookmark not defined.
Session 1-4: Stochastic Integrals and Time Averages ......... Error! Bookmark not defined.
Session 2-4: Ergodicity ........................................................ Error! Bookmark not defined.
List of Figures
Figure 1-1 ................................................................................. Error! Bookmark not defined.
Figure 1-2 ................................................................................. Error! Bookmark not defined.
Figure 1-3 ................................................................................. Error! Bookmark not defined.
Figure 1-4 ................................................................................. Error! Bookmark not defined.
Figure 1-5 ................................................................................. Error! Bookmark not defined.
Figure 1-6 ................................................................................. Error! Bookmark not defined.
Figure 1-7 ................................................................................. Error! Bookmark not defined.
Figure 1-8 ................................................................................. Error! Bookmark not defined.
Figure 1-9 ................................................................................. Error! Bookmark not defined.
Figure 1-10 ............................................................................... Error! Bookmark not defined.
Figure 1-11 ............................................................................... Error! Bookmark not defined.
Figure 1-12 ............................................................................... Error! Bookmark not defined.
Figure 1-13 ............................................................................... Error! Bookmark not defined.
Figure 2-1 ................................................................................. Error! Bookmark not defined.
Figure 2-2 ................................................................................. Error! Bookmark not defined.
Figure 2-3 ................................................................................. Error! Bookmark not defined.
Figure 2-4 ................................................................................. Error! Bookmark not defined.
Figure 3-1 ................................................................................. Error! Bookmark not defined.
Figure 3-2 ................................................................................. Error! Bookmark not defined.
Figure 3-3 ................................................................................. Error! Bookmark not defined.
Figure 4-1 ................................................................................. Error! Bookmark not defined.
Figure 4-2 ................................................................................. Error! Bookmark not defined.
vi
vii
UNIT 1
PRELIMININARY MATHEMATICAL CONCEPTS
Introduction to Unit 1
In this introductory unit, we briefly review classical optimization which is the basis of
consumer optimizing behaviour. Next we deal with the basic concept of axioms of choice and
indifference curves. After the preliminary notions of probability theory, we present the main
ideas and fundamental properties. We continue with definitions and discussions on the
concepts of transformations, continuity, and differentiation.
Note
The converse of the above theorem is not true
Example
Consider the function f ( x) x 3 , we note that although f ' (0) 0 , x 0 is neither a maximum
nor a minimum point; in fact, it is a point of inflection.
point
Similarly, f is said to have a local minimum at a point x* n , if, for some 0 ,
local
extremum
at x* n ,
point
then f ( x*) 0 ;
i.e.
f ( x*) f ( x*)
f ( x*)
...
0
x1
x2
xn
Note
The converse of the above theorem is not true
2 f
xi x j
h11 h12
h11 h12
0 , h21 h22
h11 0 ,
h21 h22
h31 h32
h13
h23 0 ,
h33
A Symmetric Matrix is negative definite if its principal minors alternate in sign as follows:
h11 h12
h11 h12
0 , h21 h22
h11 0 ,
h21 h22
h31 h32
h13
h23 0 ,
h33
Summary
Thus, for a multivariable function such as f : 2 with ( x, y) 2 ; for (x,y) to be a local
minimum or maximum three conditions must be met
1) The first order partial derivatives must equal zero simultaneously. This indicates that
at the given point (a, b) is a critical point at which the function is neither increasing
nor decreasing with respect to the principal axes but is at a relative plateau
2) The second-order direct partial derivatives when evaluated at the critical point must
both be positive for a minimum and negative for a maximum
3) The product of the second-order direct partials evaluated at the critical point should
exceed the product of the cross partials evaluated at the critical point.
Local Maximum
Local Minimum
1. fx = 0 and fx = 0
1. fx = 0 and fx = 0
is called a Lagrange multiplier. Similar necessary and sufficient conditions for local
extrema then apply
For a linear constraint on R2 the Hessian is said to be bordered and the sufficient (second
order) conditions are given by
h11 h12
h11 h12
0 , h21 h22
h11 0 ,
h21 h22
p1 p 2
p1
p 2 0 for a minimum
0
and
h11 h12
h11 h12
0 , h21 h22
h11 0 ,
h21 h22
p1 p 2
p1
p 2 0 for a maximum
0
Again note that here the Hessian of L is the matrix of its second order derivatives and is given
by
2L
2L
for i, j 1,2 and pi
xi x j
xi
g ( x1 , x2 ) p1 x1 p2 x2 C 0
Example
1) Optimize the function z = 4x2 + 3yx + 6y2 subject to the constraint x + y = 56
Solution
Set the constraint equal to zero:
56 + x y = 0
Z
8 x 3 y '.............(1)
x
Zx
Z
3x 12 y 0.....'.............(2)
y
Zx
Z
56 x y 0
Now from 1) 8x + 3y =
8(36) + 3(20) =
= 348
Substituting the critical value in Z:
Z = 4(36)2 + 3(36)(20) + 6(20)2 + 348(56 36 20) = 9744
Since Zxx > 0, Zyy > 0 the optimal value is a minimum
: ( X is preferred to Y)
YX
: ( Y is preferred to X)
X Y
2)
Axiom of Transitivity
X Y ,Y Z X Z
X Y ,Y Z X Z
3)
Indifference Curves
An indifference curve is the locus of points or particular combination of goods each of which
gives the same satisfaction.
Utility, which is the measure of consumer satisfaction, is that function the level curves of
which are the indifference curves. Along a particular indifference curve, utility is constant.
Utility can thus be represented by a utility surface.
are everywhere dense i.e. an indifference curve passes through any point on in the
commodity space
2)
3)
cannot intersect
4)
L U
Px ()
X X
L U
Py () .(3)
Y Y
L
XPx YPy I 0
Px
Px
Marginal utility divided by price must be the same for all commodities. The ratios give the
rate at which satisfaction would increase if an additional cedi were spent on a particular
commodity. If more satisfaction could be gained by spending an additional cedi on X rather
than Y, the consumer would not be maximizing utility. He could increase his satisfaction by
shifting some of his expenditure from Y to X.
The Lagrange multiplier is the marginal utility of income. The marginal utility of income is
positive.
Again, from (3), the first order condition for the optimization problem can also be written as
10
L / X Px
L / Y Py
Thus, the ratio of the marginal utilities must equal the ratio of prices for maximum.
Now U(X,Y) = constant along an indifference curve and hence
U
U
dX
dY 0
X
Y
MU x
dX
dY
MU y
0
dX
dY
MU x MU y
dY
dX
dY MU x
dY MU x
MRS yx
dX MU y
dX MU y
As one moves from A to D the MRSyx decreases. MRS tends to turn against the commodity
that is abundant and in favour of the commodity that is scarce. The budget line equation with
y as subject is given by
Px
I
X
Py
Py
The consumer attains equilibrium on the budget line. At point F, the slope of I2 and the slope
of the budget line are the same i.e.
11
MRS YX
PX
PY
MU X PX
MU X MU X
MU Y
PY
PY
PY
Linear Indifference Curves
Suppose I is an Indifference curve MRS is constant the commodities
are perfect substitutes. If the slope of budget is different from the indifferent curves then we
have specialization.
= income elasticity
0 inferior goods
0 2 1 normal goods
U xx U xy
U yx U yy
Px
Py
Px
Py 0
0
Expanding, we get
Px
U yx U yy
Px
Py
Py
U xx U xy
Px
Py
Px PyU yx Px U yy Py U xx Py PxU xy 0
2
2Px PyU xy Px U yy Py U xx 0
2
Substituting
Px
U / X
and Py
U / Y
we have
U / X U / Y
U / X
U / Y
2U xy
U yy
U xx
0
U U
U
U
2U xy
U yy
U xx
0
X Y
X
Y
2
13
Demand Function
Ordinary Demand Function
A Consumers ordinary function sometimes called a Marshallan demand function give the
quantity of a commodity that he will buy as a function of commodity prices and his income.
The demand function can be derived from the analysis of utility maximization. Using the
first-order conditions of maximization the demand functions can be obtained.
Example
Let us assume that the utility function is U = XY and the budget constraint.
I XPy YPx = 0. From the expression
L = XY + (I - XPy YPx) and its partial derivatives equal to zero
L
Y Py 0
X
L
X Px 0
Y
Solving for X and Y gives the demand functions
X
M
2 Px
and Y
M
2 Py
2)
1a)
The first property follows from the strict quasi-concavity of the utility function, a
single maximum, and therefore a single commodity combination corresponds to a given set of
prices and income
NB
If the utility function were quasi-concave, the indifference curves would possess straight-line
portions and maxima would not need to be unique. In this case more than one value of the
quantity demanded may correspond to a given price, and the demand relationship is called a
correspondence rather than a demand function.
2b)
To prove the second property, assume that all prices and income change in the
14
KI - KXPX - KYPY can be written as K(I XPX - YPy) = 0 . Since K 0, I - XPx YPy = 0
Eliminating K from the first two equations of the first-order conditions for a maximum
we have
Uy
Ux
KPx
U
P
x x
KPy
U y Py
U x Px
U y Py
Therefore the demand function for the price-income set (KPx,KPy, KI)) is derived from the
same equations as for the set (Px,Py, I)
expenditure subject to the constraint that his utility is at the fixed level U (This is the dual
optimization problem)
Assume again that the utility function is U = XY. From the expression
Z = XPy + YPy + (U - XY) and setting its partial derivatives equal to zero, we get
Z
Px UY 0
X
Z
P2 UX 0
Y
Z
U XY 0
15
Now Px = UY , Py = UX
XPx
Px Y
and Y =
Py
Px X
XPx YPy
YPx
Px
X 2 Py
Py
UPy
Py
..Y
UPy
Py
Demand Curves
In general the consumers ordinary demand function Qy is written as q1 = (P1, I) or
assuming that P2
Given parameters, p2 and I as fixed, q1 = D(P1) is the demand curve for commodity 1. It is
often assumed the function possesses an inverse such that price may be expressed as unique
function of quantity.
Generally demand curves are negatively sloped which implies that the lower the prices, the
greater the quantity demanded.
In exceptional cases the opposite may hold.
consumption. If the consumer derives utility from a high price, the demand function may
have a positive slope.
Price Elasticity of Demand
The quantity demand of a commodity depends upon its price. It is of interest to measure the
relative change in quantity demanded as a result of given proportional change in price. This
measure is called the price elasticity of demand.
Definition
16
The price elasticity of demand is the relative responsiveness of quantity demanded to change
in commodity price in other words price elasticity is the proportional change to quantity
demanded divided by the proportional change in price.
Let e be own price elasticity of demand for the commodity X, then e
Let the demand curve for commodity be q1 = f (P1, P2 ,..., Pn, I) where q is the quantity
demanded, pj the price of the jth commodity, I is the income and we assume there are n
commodities. By definition, the own price elasticity of demand is
eii
qi pi (ln qi )
pi qi (ln pi )
A numerically large value for an elasticity implies that the quantity is proportionately very
responsive to price changes. If e0 < -1, then the good is a luxury good. (A numerically high
value). If e0 > -1, then the good is a necessity. (A numerically small value)
( p1q1 )
q
p q
q1 p1 1 q1 1 1 1
p1
p1
q1 p1
= q1 (1 + e11)
( p1 q1 )
q1 (1 e11 )
p1
Thus the consumer expenditure on q1 will
i)
ii)
iii)
(necessity)
(luxury)
The
price
cross-elasticity of
demand
measures
the
relative
e11
q1 p1 q1 P1
,
q1
P1
P1 q1
OR
17
e xy
(ln q x ) q x p y
(ln p y ) p y q x
I)
II)
Px NY
MXYdp
p x dX
Px XY
we get
IXYdp
Py XY
Px XY
P XY
x
Xdp x p y dY
0
IXYdp x IXYdp x
IXYdp x
dX p x XYp x dp x X 2 PxY dY Py Py Y
0
dp x X IY
Px IXY
dp x Y IX
e xx
Xp x Xp x
PY
e yx x x 0
I
I
I
x exx y e yx x where
YPy
XPx
, y
are the proportions of total expenditures
I
I
for the two goods. Given e11 (own price elasticity of demand) for q1 the formula
1 (1) 2 e21 1
2 e21 1 1
2 e21 0 e21 0
ii)
1e11 1, e21 0
Then - 1 + 1 e11 > 0 hence 2 e21 0 e21 0
Similarly,
iii)
1 e11 + 2 e21 1
18
2 e21 1 1e11
e21 1
(1 e11 )
(1 e11 )
e21 0
Income Elasticity of Demand
Income elasticity of demand for an ordinary demand function is defined as the proportionate
change in income with prices constant
( InX )
( InI )
Px dX + Py dY = dI multiplying through by
X
Y
and dividing by dI, we get
, the second by
X
Y
I X
IY
I
Px dX
Py dY dI
I X
IY
I
I X Px dX I Y Py dY dI I
I X dI
I Y dI
dI I
dX I XPx dY I YPy
1
dI X I
dI Y I
XPx dX I YPy dY I
1
I dI X
I dI Y
11 2 2 1 where
YPy
XPx
, 2
M
M
19
dTR
dq
MR
dTR
dp
q dp
pq
P1
dq
dq
p dq
But
p dq
q dp 1
e
q dp
p dq e
20
SOLVED PROBLEMS
Example 1
A consumer spends $360 per week on two goods and X and Y and Px = $3 and Py =$2.
His utility function is U = 2X2 Y. What quantities of X and Y does he buy each week in
equilibrium. Check whether the second-order condition of maximum is satisfied
Solution
We have: I = $360, U = 2X2Y,
MU x
Thus
U xy
PX = $3, PY = $2
U
U
4 XY and MU y
2X 2
x
y
U
U
4 X
U yx
x y
y x
U xx
U
U
0
4Y ,U yy
x x
y y
At equilibrium
MU x 4 XY Px
2YPy XPx
MU y 2 X 2 Pv
YPy XPx I
And since
We have
3YPy I
And therefore
Y
YPy
Also
I
60
3Px
1
1
XPx XPx XPx I
2
2
2I
80
3Px
U U
U
U
2U xy
U yy
U xx
0
X Y
X
Y
2
Substituting values of the first and second order derivatives of U on the LHS, we get
Which, simplifies to
64 X 2Y 16 X 2Y 0 0Y 0
21
Example 2
A consumer spends $450 per week on two goods X and Y, with PX = $5 and PY = $3.
His utility function is U = 0.5XY2.
i)
ii)
Solution
I = $450, PX = $3, PY = $2, U = 0.5XY2
Thus, MU x
U
U
0.5Y 2 , MU y
XY
x
y
At equilibrium
MU x Px
0.5Y 2 Px
0.5YPy XPx
XY
Py
MU x Px
Thus, YPy XPx I becomes YPy 0.5YPy I
i) Hence
2I
3P y
Hence,
I
3P x
ii) Numerically, X
2 I 900
I
450
100
30 and Y
3Py
9
3Px 15
Example 3
A rational utility-maximizing individual lives in a world with only two goods: X and Y.
His utility function is given by U(X,Y) = XY . His money income is $256 per week and
PY = $8
a)
b)
22
Solution
I $256 x Py $8,U XY
MU x
U 1
Y
X 2
X
MU y
U 1
X
Y 2
Y
At equilibrium
MU x Px
Y P
x YPy XPx
MU y Py
X Py
Thus, YPy XPx I becomes 2YPy I
And his demand curve for Y is given by Y
The equilibrium quantity of Y: Y
I
2 Py
I
256
16
2 Py 16
Example 3
Total Revenue from the sale of a commodity is given by the equation
TR 100Q 2Q 2
Solution
Marginal revenue MR is given by
dQ P P
dP Q 2Q
P 60
Example 4
A rational utility-maximizing individual lives in a world with only two goods X and Y.
23
His utility function is U ( X , Y ) XY . His money income is $256 per week and Px = $8
a)
b)
If the price of Y is $2
i)
ii)
c)
He is given the option of joining a club, for dues of $176 per week which would
give him one but only one, of the following rights concerning purchases for his
own consumption:
i)
ii)
iii)
He could buy both X and Y at 75% of the normal prices. The normal prices
are still Px = $8 and Py = $2 and his income before payment of dues is still at
$256 per week.
Will he join the club, and if so, will he choose option (i), (ii) or (iii)?
Solution
MU x
U 1
Y
X 2
X
MU y
U 1
X
Y 2
Y
At equilibrium
MU x Px
Y P
x YPy XPx
MU y Py
X Py
Thus, YPy XPx I becomes 2YPy I
And his demand curve for Y is given by Y
I
2 Py
I
the demand for Y is independent of the price
2 Py
of
X and hence the cross-elasticity is zero
24
I
dX
1
2 Px
dI 2 Px
dX I
1 I
1
I
=
1
dI X 2 Px X 2 Px I / 2 Px
Using the demand equations derived above with given income and prices we know
that
if he does not join the club his position is
I
1 256
64
2 Py 2 2
I
1 256
16
2 Px 2 8
U (16)(64) 32
i)
If joins and buys X at 50% of the normal price his position is:
Px
50
x8 $4
100
I
1 180
22.5
2 Px 2 4
I
1 180
45
2 Px 2 2
U (22.5)(45) = 22.5 2
iii)
Py
50
x 2 $1
100
I
1 180
90
2 Py 2 1
I
1 180
11.25
2 Px 2 8
25
U (11.25)(90) = 22.5 2
iii)
If he joins and buys both X and Y at 75% of normal price his position is
Px
75
75
x 2 $3
x8 $6 and Py
100
100
I
1 180
15
2 Px 2 6
I
1 180
30
2 Py 2 3
U (15)(30) = 15 2
Thus he will join and be indifferent to options (i) and (ii) because his utility in each case is
22.5 2 which is greater than the utility before joining the club which is 32 .
It is thus not worth joining in respect of option (iii).
Example 5
The relationship between a consumers income and the quantity of X he consumes is given
by the equation
I 1000Q 2
Calculate his point income elasticity of demand for X when his income is 64,000.
Solution
Q2
I
64000
Q
8
1000
1000
And
dQ I
1
dQ
1
64000 1
dI Q (2000)(8) 8 2
dI 2000Q
Example 6
A town of 2,000 households constitutes a market for eggs. Current sales are 2,400 dozen
eggs per week of $1.25 per dozen 1,200 households living on the west side of the river buy
1,600 dozen and their elasticity of demand is 1.5. The remaining households live on the east
of the river, buy the rest of the eggs, and have an elasticity of demand of -3 calculate the
elasticity of the market demand curve for the town as a whole.
Solution
26
If two-thirds of eggs are subject to an elasticity of 1.5 and-third to -3 the combined elasticity
is the weighted average.
2
1 2
1.5 x 3x
3
3 3
Example 7
An individual spends his income on three goods. He buys 550 units of X at $1 per units,425
units of Y at $2 per month units, and 200 units of Z at $3 per unit. He now buys 440 units of
Y and 190 units of Z. Calculate his price elasticity of demand for X.
Solution
Old expenditure on Z = 200 x 3 = $600
Old expenditure on Y = 425 x 2 = $850
Total expenditure on Y and Z = $1450
New expenditure on Y = 440 x 2 = $880
New expenditure on Z = 190 x 3 = $570
Total expenditure of Y and Z = $1450
Expenditure on Y and Z remains unchanged hence expenditure on X remains unchanged.
Therefore the price elasticity of demand for X is -1.
Example 8
An individual lives in a world where there are only two goods X and Y. His utility function
per period is:
U = 50X 0.5X2 + 100Y Y
The price of X is 4 and his income per period is 672.
b)
c)
d)
27
e)
The individual is given the opportunity to join a society whose members can buy
Y at z price of 5, this would be individuals only benefit from membership. What
is the maximum amount that he would just be prepared to pay in membership dues
each period to join the society?
f)
Suppose the membership dues are 222 per period. Will he join? What then would
be the marginal utility of money to him?
Solution
a)
MU x Px
,..and .. XPx YPx I
MU x Px
MU x Px
,..and .. XPx YPy I
MU y Py
U = 50X 0.5 X2 + 100Y Y2
MU x
U
U
50 X , MU y
100 2Y
X
X
X=
100 Px 2YPx 50 Py
Py
50 Py 2YPx 50 Py
Py
50 Py 2YPx 100 Px
But XPx + YPy = I so Px
YPy I
Py
Y
b)
Py I 100 Px2 50 Px Py
2 Px2 Py2
Given that Py = 14 Px = 4
28
Py I 100 Px2 50 Px Py
2 Px2 Py2
14 x672 100 x 4 2 50 x4 x 4
2 x 4 2 x14 2
9408 1600 2800
36
32 196
MU x Px
P
50 X
..so...
x
MU y Py
100 2Y Py
Hence
50Py - XPy = 100Px 2YPx
2YPx = 100Px 50Py + XPy
100 Px 50 Py XPy
2 Px
100 Px 50 Py
XP Py
I
2
P
x
2 Px I 100 Py Px 50 Py
2 Px2 Px2
2 Px I 100 Py Px 50 Py
2 Px2 Px2
Income elasticity
dX I
But
dI X
2 Px
dX
dI 2 Px2 Py2
29
2 Px
I
substituting the values of
2
2
2 Px Py X
2 x4
672
8
672
,
x
0.56103508 5614(4d . p)
2
2 x4 14 2 42 32 196 42
If joins he would not like his utility to fall at least he would want t0 maintain his
original utility. When X = 42 and Y = 36 his
U = 50(42) 0.5(42)2 + 100(36) 362 = 3522
MU x Px
50 X
4
MU y Py 100 2Y 5
i.e. Px = 4, Py = 5
250 5X = 400 8Y
8Y = 400 + 5X 250
150 + 5X
But U = 3522
150 5 X 150 5 X
U 3522 50 X 0.5 X 2 100
8
8
15000 500 X
50 X 0.5 X
8
8
2
3522
64
40
8
8
30
e)
Since 222 is less than 336 he will join. His new remaining income is $672-$222 =
$450
MU y
Px
MU y
Py
THEORY OF PRODUCTION
The two fundamental concepts behind supplies decision are:
31
i) Production
ii) Cost
All economic goods come to existence through the process of production. This includes
production. This includes production of goods and services e.g. Legal service, medical etc.
In the theory of the firm, the theory of consumer behaviour consumer maximize satisfaction
and firms maximizing profits. In production we have Marginal rate of Technical Production
between inputs. In the theory of consumer behaviour consumers maximize ordinal utility. In
the theory of the firm, the firms maximize cardinal variables. The production process utilizes
the production of inputs e.g. Capital goods i.e. intermediate products, all capital goods come
into existence through an act of production.
Assumption
1)
We have one variable input, one fixed input and they may be combined in
various proportions.
Example
Q= f(K,L),
K is fixed capital; L, labour is assumed variable
The figure below depicts total output at alternative units of variable inputs. At L=0, Q = 0
since capital alone cant produce an output: we need L to combine.
The Average product of L:
APP
= Q/L
32
ISOQUANTS
33
Isoquants are curves input space showing all positive combinations (bundles) of inputs that
are capable of producing a given output. Isoquants are downward sloping. They dont
intersect. Isoquants are convex to the origin. A higher isoquant is preferred to a lower one.
The downward slope implies that if one increases one input one has to reduce the other and if
one decreases the one, one should increase the other. The further away from the origin an
isoquant is, the higher the associated level of output. MR of Technical
Substitution
KL, MRTSKL =
dK
measures the number of units of K that replaces a unit of L at a point
dL
so as to produce a given level of output. Along an isoquant the level of output is constant and
therefore
Q = F(K,L)
dQ = Fkdk + FdL
Along the isoquant Q = constant
dQ = 0
0 = Fk dK F1dL
dK FL
MRTS k1
dL Fk
As L is substituted for K along an isoqunt the MRTSKL declines law of diminishing
MRTSKL
L
ISOCOST CURVE:
R rental rate of capital
W wage rate of labour
Optimal way in which the firm combines various input is given below
We assume that the firm purchases from a P.C input market (prices are given) The T.C of
purchasing K and L is C = PkK + PLL i.e C = rK + wL
C = rK + wL
w
C
L isocost curve (or equation
r
r
34
Slope
w
r
The totality of all the isocost curves is the isocost map. We first consider profit maximization
-
Profit = Revenue-Cost
= PQ (rK + wL)
If firm is a Perfect Competitor in the input market and in the output markets and in this
case P is given, then when C is minimum would be maximum output for given cost or
minimum cost for a given output. Implies we are moving along a given isoquant.
An
isocost curve further away form the origin corresponds to a higher TC. It is not possible
to produce at C. The cost minimization point is E where the isocost curve is tangential to
the isoquant. At E therefore
MRTS
MPPL w
MPPK
r
If the above question is not satisfied, the producer will substitute one of the inputs for the
other. From the equation
MPL MPL
r
,
marginal cost of labour per unit of output
MPK MPL MPL
W is the unit cost of labour. MPL is how much output increases if we increase the number of
labour by 1.
r
marginal cost of capital per unit of output
MPL
r
w
MPx MP
MPL w
MPL r
MPL MPK MPL
output per units of labour
w
r
w
MPK
output per unit of K
r
35
Instead of minimizing cost we can maximize output in the dual optimization problem. Now
output varies and cost is
Qx is not attainable Q1 is attainable but not the right equilibrium position
At E, MRTS = ratio of prices. Equilibrium is the same in both cases.
DEFINITION OF SOME CONCEPTS
Isocline is the locus of points along which MRTS is constant. It connects points along which
MRTS is the same.
K
Expansion path
Suppose inputs prices are given and the firm wants to expand output.
2)
3)
36
There are certain cases where inputs can be doubled example extractive
industries-mining
THEORY OF COST
37
Social cost of production, when resources are used to produce a commodity it implies the
society in curs a loss of production of another commodity
Opportunity cost the opportunity cost of producing one units of X is the amount Y that must
be sacrificed for producing X
Explicit Cost. Are payments made by firms for purchase or hired factors of production
Implicit Cost: Are the imputed cost of self-owned factors of production
Total Cost Explicit: Implicit Costs
Implicit and Explicit costs are private costs of production.
In economics, cost means opportunity cost unless otherwise stated.
of
the
expansion
path.
L
TC is concave to the origin at low levels of output and becomes convex. It starts from the
origin. The shape of the curve reflects the characteristics of the production function. It
reflects return to scale.
1st TRS, 2nd CRS 3rd DRS
38
SMC '
d ( STC ) d (dQ
TFC
, AFC
dQ
dQ
Q
39
AVC
SMC
TVC w.L
L
w.
Q
Q
Q
d (TVC ) dL d (TVC dQ
w
,
dL
dQ
dL
dL MPPL
dQ
Marginal product of labour
dL
dQ
dL
Both the SRVC , STC start from the origin is asymptotic to the cost axis. The gradient of the
ray from the origin to the STC gives the ATC at that point
LONG-RUN COST CURVES
In the long run, all inputs are variable. It is the planning of the firm. The long-run cost
curves are always below the short-run cost curves. If a firm wants to take a decision it
happens in the long-run. LCRC SRC>
All production take place in the short-run. As we move towards the LR, the fixed factor
becomes variable. We have a series of SRC curves. The LTC is the envelope of the possible
short-run TC curves. The long-run LTC is also the envelope of all the possible short-run, AC
curves.
40
FUNCTION COEFFICENT
It shows the proportionate change in output when all inputs are changed by the same
proportion. If is the change in input then function coefficient
LAC
C Q C
,
LMC
C
Q
C
Q C
Q LAC
,
LAC
Q C
C LMC
41
LAC
C
Average cost
LMC
Q
1 LAC LMC
1 LAC LMC
1 LAC LMC
If the production function exhibits CRS then the expression path is linear i.e. through origin.
If the production function is linear, it implies CRS
If expansion path is linear then it belongs to homothetic production functions.
42
1.
1)
2)
We classify industry whether there are many firms, few or one firm in the industry
2.
We categorize the industries by whether the products of the firms are homogeneous or
different
Number 0f Firms
Number of product
Many
Few
Homogeneous
PC
Pure Oligopoly
Differentiated
MC
Differentiated
One
Monopoly
Oligopoly
PC Perfect competition
MC Monopolistic competition
We use the world competition to imply many firms in the industry
Oligopoly implies few firms in the industry.
Perfect and Pure implies homogeneity of product
Competition does not mean competition in the real sense of the word. Here rivalry is absent.
All other market structures other than perfect are classified as imperfect competition. We are
talking about the sellers side of the product. We have the counterpart of this that is those who
do the buying.
If the buyers are many implies perfective competitive buyer
If there is one buyer, then the market is monopsonistic
If a monopolist faces a single buyer, we have a bilateral monopoly
43
PERFECT COMPETITION
Economists use four conditions to characterize perfect competition
1)
2)
3)
Free mobility of resources, i.e. are perfectly mobile. There are no special skills
that one needs
4)
Perfect knowledge producers and owners of factors production and buyers have
knowledge about the economy. Market participants have knowledge about the
future
P1
B
D1
D2
The market period only supply determines the equilibrium output and demand determines the
price.
STC
=TR-TC
TC
Fixed
Cost
=0
44
=0
MR = MC
2)
MC must be increasing
d d (TR) d (TC )
0
dQ
dQ
dQ
MR - MC = 0
MR MC
d 2
0
dQ 2
d 2 (TR) d 2 (TC )
0
dQ 2
dQ 2
d ( MR) d ( MC )
0, MR = constant PC
dQ
dQ
d ( MC )
0
dQ
MC is an increasing function
MC is increasing
45
At the min point of the SAC the firm is indifferent about production i.e. it can continue to
produce or shut down. That is at this point the firms covers its variables costs.
LONG-RUN EQUILIBRIUM OF PC
The long-run adjustment of a single firm
In the long-run the firm will operate at point E. At q, the firm will be making profits hence
new firms will enter into the industry.
LONG-RUN EQUILIBRIUM THE INDUSTRY
At qi, the firm will be making profits hence new firms will enter hence the curve will shifts to
right that is S1 S 2 .
46
At q, firm will be making losses firms will be leaving the industry. At q, supply to S 1. As
firms leave the industry the long-run supply will be S2 .
MONOPOLY
If there is only one producer in the market then we have monopoly. Monopoly and PC are
extreme cases.
1}
2}
In the case of monopoly rivalry does not exist. There is only firm in the in the market.
However there are indirect forms of competition that the monopolist faces.
i)
ii)
The existence of substitutes for his products. His power depends on the
exact goods. Reasons why monopolists exist
1)
Control of the basic input. That is the Aluminum Company of USA owns the Bauxite
A firm can obtain the property right to produce a commodity. They cannot prevent
other firms from producing close substitute example Pata and Club, IBM and the rest
3.
The Average Cost of producing a product reaches its minimum at an output rate that
Demand curve facing the monopoly. The dd curve facing the monopolist is the same
Under monopoly the firm chooses the price. The MR is not the supply curve as is the
case.
SHORT-RUN EQUILIBRIUM OF THE MONOPOLIST
A firm may be a monopolist in the product market and may be a PC in the input market. If it
is a PC in the input market then the cost curves will be the same as the PC.
47
Let us consider a monopolist who owns two plants. Each of the plants has its own cost
curves. He decides on output and price. The allocation of optimal output in each plant are as
follows:
Total Market
MC MC1 MC2 MC
P
P
MC = MR
D
Q
p FR (Q)
P F (q1 q 2 )
Q q1 q 2
R pq qF (q1 q2 )
R(Q) f (q1 )
C=fq1),C2=g(q2)
R(q1 q2 ) C1 (q1 )
= R(q1 + q1) g(q2)
Q
Q
R(q1 q 2 )
f ' (q1 )i.e.
1
q1
q1
q2
R Q
,
P(q1 ) R' f ' 0 R' f ' MR Mc
Q q1
Q
R' (q1 q 2 )
g' 0
q 2
q1
R' R' 0, MR MC
48
2
q1 2
2
q1q 2
2
q 2q1
q 2
11 12
12
, 11 0. 11
0
21 22
21 22
The second order condition implies MC must be rising.
LONG-RUN EQUILIBRIUM
Since entry is blocked in the LR profit is not reduced to zero. If the monopolist incurs a SR
loss and there is a revenue for expanding output then in the LR it will close down. If the
monopolist makes profits in the SR, he can expand output. The maximum-maximum plant is
the plant which gives the maximum of the maxima profit.
That is LMC = MR
SAC is the optimal plant of the LR. The maximum-mximum plant is the plant which gives
the maximum of all profits. In the LR, monopolist need not operate at the minimum point of
the LAC, so reso@
49
LMC = LAC
A
B
D
Qp
q
Qp
q
Q
q
Q
. And the monopolist will change a higher price.
q
50
QUESTIONS
Construct a short-run supply function for an entrepreneur whose short-run cost function
is TC = 0.04q3 0.8q2 + 5 + 10q
1)
Solution
TC = 0.04q3 0.8q2 + 5 + 10q
TVC = 0.04q3 0.8q2 + 10q
AVC
TVC
0.06q 2 0.8q 10
q
dAVC
0
dq
dAVC
0.08q 0.8 0
dq
q
80
10
8
20 5 3 p 14
3
The positive branch gives output at which MC is increasing, hence dS/dp >0 and
S=
20 5 3 p 14
.if..p 6
3
2) The long-run cost function for each firm that supplies Q is C = q3 4q + 5q.
51
Firms will enter the industry if profits are positive and leave the industry if profits are
negative. Describe the industrys long-run supply function. Assume that the corresponding
demand function is D = 2000 100p.
Determine equilibrium price of industry and number of firms
OTHER QUESTIONS
1)
is positive constant A, B and C are the weekly outputs of the three factors used.
The price of A is $1, the price of B is $ and the price of C is $8
a)
i)
ii)
iii)
b)
if the short-run factor C is fixed, while factors A and B are variable, derive the
following
i)
ii)
iii)
iv)
c)
Derive an equilibrium in the form C = f(x) showing the optimum quantity of the fixed
factor
C for the firm to acquire as a function of the intended output of X
Solution
The equilibrium or cost-minimum conditions are
MPPa Pa MPPa Pa
,
MPPb Pb MPPb Pb
From th given data
52
MPPa Pa
0.5A0.5 B 0.5 C 0.25 1
=
MPPb Pb
0.25A0.5 B 0.5 C 0.25 9
So
2e 1
A
C .............(ii )
A 8
16
A A
X A0.5
9 16
A0.5
X
0.25
( A) 0.5 ( A) 0.25
3
2
6
A0.25 A
6
.0.8
X 0. x .................(iii )
= AS1)
A
A
($9) ($8)
9
16
A A
But
6
A
A 5A
2
2
0.8
X 0.8
5 6
Hence LTC =
2
0.8
X 0.8
0.8
(i)
5 6
LTC = X 0.8
2
(ii)
LTC
5 6
LAC =
2
X
0.8
X 0.81
0.8
5 6
= X 0.8
2
53
(iii)
b)
LMC =
dTC 5
6
(0.8)
dX
2
0.8
X 0.2
4 6
2
X C
0.25
A
9
AC 0.25
3
0.5
A0.5 C 0.25
A
3
A
3
3X
C 0.25
SFC = AP + BP + CP
But
A
($9) $8) A A 8C
9
STC = 2A + 8C
A
But
3X
C 0.25
6X
3X
Hence STC = 2 0.25 8C
8C
C 0.25
C
SAC
(ii)
STC
6X
8C
0.25
X
X
C
=
(iii)
SAVC =
Hence SAVC
v)
SMC =
SMC =
6
8C
0.25
X
C
TVC
6X
, but...TVC
X
C 0.25
6
6X
/X
0.25
C 0.25
C
dSTC
d 6X
6
8C
0.25
0.25
dX
dX C
C
6
C 0.25
16
C
9
54
0.8
6
X 0.2 2
0.8
X 0.2
0.5
16
X (16C ) C C 0.25
9
X AC 0.5
3
C
16
2)
0.8
X 0.8
A firm uses a number of factors to produce a single product. X. In the short-run plant
is fixed, while all other factors are variable. We are concerned with two of the possible
plants. In the long long-run of course all factors are variable. The cost functions are
LTC = 0.005 X3 1.4X3 + 280X
Plant 1 : STC1 = 0.006X2 -1.33X2 + 6860
Plant II STC2 = 0.0057 X2 -1.424 X-2 + 205.6X + 10240
a) Derive equation for the following LAC, LMC, SAC, SATC,..SMC,,SMC
b) At what output does the firm achieve minimum LAC?
c) Does either plant permit achievement of minimum LAC?
d) At what output is SAC, minimized?
e) What is the level of SAR at 160?
f) What is the level of SAC at X = 160?
g) At what is the SAC minimized?
h) Which of these two plants will the firm use if it intends to produce the
output in (g)
i) For what output would plant 2 be the best of all possible plants
j) Would plant 1 operate in the short- run if the product price were 120?
k) Would plant 2 operate in the short-run if the product price were 120?
l) Which plant would be more profitable if product price were 120?
m) At what product price would the firm produce the same positive output in
the short-run which ever of these two plants it had?
55
Solution
LTC = 0.005X3 -1.4X2 + 280X
a)
LAC =
LTC
0.005 X 2 1.4 X 280
X
LTC
0.15 X 2 28 X 280
X
STC1
X
SAVC =
STC1
but SFC = 6860
X
SAFC1 = 6860X-1
SMFC1 =
dSTC1
0.018 x 2 2.66 x 201.6
dX
STC1
= 0.0057X -1.424X + 205.6 + 10240X-1
X
dSTC
0.0171x 2 2.848 x 205.6
dX
For min
dLAC
0 0.01X 1.4, X 140
dX
d 2 LAC
0
dX 2
d 2 LAC
0.01 minimum, hence X = 140
dX 2
56
or
LAC = LMC
LAC = 0.005X2 1.4 + 280
LMC = 0.015X2 2.8X + 280
0.005X2 1.4X + 280 = 0.015X2 2.8X + 280
(0.005 0.015) X2 1.4X + 2.8X = 0
-0.01X2 + 1.4X = 0
X(-0.01X + 1.4) = 0
X = 0 or X = 140
X = 140
C)
SAC1 at X = 140 is
6860
SAC1 = 0.003(140)2 - 1.33(140) + 201 +
182
140
SAC at X = 140 is
10240
SAC = 0.0057(140)2 1.424(140) + 205.6 +
191.1
140
LAC at X = 140 is
LAC = 0.005 (1402) 1.4 (140) + 28 = 182
Hence plant 1 achieves minimum LAC
d) Find the minimum of SAC. Thus we find the derivative of SAC , and set it equal to zero
and check whether it is a minimum
SAC1 = 0.006X2 -1.33X + 201.6 + 6860X-1
dSAC1
dSAC1
6860
0.912 x,1.33 6860 x 2 ..Set.
0 0.012 x 1.33
0
dX
dX
X2
d 2 SAC1
0
dX 12
d 2 SAC1
2(6860)
13750
0.012
0.012
2
3
dX 1
X
X 3
57
d 2 SAC1
dX
0.012 0.005 0
x 140
0 I .E (14.58 62.21) 3 0
X X 2 , X1
dSMC2
dX
h)
That SAC2 is minimized at X = 160 does not mean that SAC < SAC1 at X = 160
At X = 160
SAC = 0.006X2 = 1.33X + 201.6 + 6860X-1
i.e. SAC1 = 0.006 (1602) 1.33 (160) + 201.6 +
6860
160
58
i)
It is necessary that SAC1 = LAC at tangency and therefore SMC2 = LMC setting
the average cost equal yields a cubic equation i.e.
10240
X
dSAMC1
dX
0.036(104.32)2.66,1.1 0
X 104
dSMC1
dX
59
Solving we get
X = 127.2, X2 = 39.36
dSMC 2
0.0342 X 2.848
dX
dSMC1
dX
STVC
X
Plant 1 would not operate and hence it will incur a loss equal to the LFC 6860
= 25.083.26
60
III)
SAVC2 SMC1
SAVC = 0.0057X2 -1.424 X + 205.6
SAVC at X = 19.5 is SAVC = 179.999
SAVC = 180
SMC2 = 0.0171X2 -2.848X + 205.6
SMC at X = 19.5 is
SMC2 = 6.50 55.536 + 205.6 156.564
Again SAVC2 > SMC2 i.e 180 > 156.564
Since (ii) and (iii) are violated, there is no such price.
1) A firm uses capital and labour to produce widgets . In the short run capital is fixed,
while labour is variable the short run production function is X=-1 + 24 + 240L where
61
X is the number of widgets produced per week, and L is the number of workers
employers employed. Each works a 40 hour week. The wage rate is $12 per hour.
a) Calculate the range of values for L over which the the firm in (i) Stage I (ii) Stage II
(iii)
b) What iis the minimum product price at which the firm will operate in the short6
run?
The product price over which the firm has no control, in such such that the firms maximum
possible pure profit is $1096 per week. In order to achieve that level of profit must employ
16 workers. How much is the firms total first cost?
Solution
a) Locate the input values at at which APP1 = 0. From the production
APP1
X
24 L 24O
L
dAPP1
2 L 24 0 L 12
dL
d 2 APP1
2 MAX POINT
dL
MPP
dX
3L 240
dL
Thus
i)
ii)
iii)
b)
w AtL
16, w 480
Px
P
w
480
$2.
MPP1 240
when L = 16
Thus total revenue = XPx = 5888 ($2) - $11776
X = (1) + 24(16) + 240(16) = 5888
TVC = $480 X 16
$7680
But profit total revenue total cost
= 11776 (7680 + TFC) = 1096
TFC = $3000
4) A firms only variable factor is labour and it produces a single product. X. It also has
fixed costs. The short run production function is X = -0.1L2 + 6L2 + 12L where X is the
output per per week in tons and L is the number of persons employed.
a) How many persons are employed if the average physical product of labour is minimized?
b) How many persons are employed if the marginal product of labour is maximized
c)
d)
Solution
a) The production function is X 0AL2 + 12L
dPPL
2 L 6 0
dL
L = 30
63
dPPL
0.2 max
dL
c)
dMPP d 2 X
0.6 L 12 L 20
dL
dL
d 2 MPPL
0.6 max
dL
MPP is maximizes when L = 20
c)
Average variable cost is minimized when APPL is maximized and from a) APPL
is maximized
when L=30. From the production function when L 30
X = -0.1 (30) = 12 (30) = 3060
d)
0.3L2 12 L 12
360
12
30
--0.3L2 + 12 = 0
Solving gives L = 0 or L = 40
Since L > 30 it is worth producing i.e. it is in stage II
When L = 40
X = -01 (40)2 + 6(40)2 + 12(40)
X = 3680
5) A typical firm in a perfectly competitive industry has the following long-run total function
LTC =q2 60q2 + 1500q where cost is measured in dollars and q is output per month:
a)
i)
ii)
b)
If the firm can sell its output at a price of p = $975, how much will it produce
to maximize profit?
64
c)
d)
If the industry is one of the constant costs, derive the equation for the long-run
supply curve of the industry7
If the market demand curve is p = 9000 3Q, howe many firms will there be in the
e)
Solution
a)
(i)
LAC
LTC
q 2 60q 1500
q
(ii)
LMC
dLTC
3q 2 120q 1500
dq
Set LMC = p
3q2 120q + 1500 = 975
3q2 120q + 525 = 0
q1 = 5,q2 = 35
But at equilibrium. LMC must be rising
dLMC
6q 120
dq
dLMC
DQ
6(5) 120 90
q 5
dLMC
dq
(35) 120 90
q 35
TR TC
But TR = 975q, TC = q3 60q2 + 1500
d 2
0
dq 2
65
d 2
6q 12
dq 2
dLMC
DQ q 5
90,
dLMC
DQ
-90
q 35
LAC
LTC
q 2 60q 1500
q
dLAC
2q 60 0 q 30
dq
d 2 LAC
2 a minimum
dq 2
Hence the industry equilibrium is q=30.
c)
p = 9,600 -2Q
If there are n-firms in the industry with each producing q units then
Q = nq and q = 30, p = 600
600 9600 2nq
A firm uses and labour to produce commodity A. In the short run the amount capital
is fixed while labour is variable. The firm buys capital at a price beyond its control and
calculates the daily cost to allow for depreciation, maintenance ETC. At the current interest
rate the cost capital is $30 per unit per day. The wage rate is $3.9 man-hour.
On the basis of those factor prices the plans and builds its plant so as to maximize profits at
expected selling price of commodity A over which it has no control firms daily cost curves
are as follows, where costs are in dollars and q is the daily of commodity A.
66
2 3
q 16q 2 180q
3
b)
How much profit did the firm expect to make per day
c)
What is the lowest price of commodity, A at which the firm will still operate in
short run if there is no change in factor prices?
d)
If the prices of commodity A is $124 and the firm expects that price to continue
indefinitely with no change in factor prices, how many commodity A per day will
firm plan to produce in the long-run?
e)
If the price of commodity A is what the firm initially expected to be, but
during initial short run the wage rate rises to $7.50 per man-hour, while the cost of
capital to $28 per unit per day, $28 per unit per day, how many commodity will
the firm produce per day in the short-run?
Solution
a)
2 1
q 16q 2 180q
3
LTC
LMC
dLTC
2q 2 16q 180
dq
SMC
dSTC
3q 2 48q 195
dq
dLMC
4q 32
dq
67
dLMC
dq
dLMC
dq
4q 32 28 LMC is falling
q 1
At q = 15
LAMC = SMC = 2(15)2 32(15)+180 = 150
The expected price was $150
b) Profit TR TC
Expected Revenue = 15(150) $2,250
Mq 15, expected LPC = SPC =
2
15) 180(15) $1350
3
TR = $2250
TC = $1350
= 2250 1350
= $900 = Expected Profit
c)
SAVC
STVC
q 2 24q 195
q
68
dLMC
4q 32
dq
dLMC
dq
4(2) 32 24
q 5
dLMC
dq
4(14) 32 24
q 14
Hence q= 14
At q = 14, LAC =
2
(14) 16(14) 180
3
= $86.67
Hence p = 124 > LAC
Therefore the firm will price 14 units of commodity A.
c) LMC = SMC = p in above SMC = $150
SMC = 3q2 48q + 195
The new marginal cost will increase by the ratio
7.5 2
3q 48q 195
3.9
SMC
7 .5
, hence the new
3 .9
Also in the short-run capital is fixed, hence the marginal cost does not depend on capital but
rather labour. To find the units of commodity A that will be produced set the new SMC
equal to $150.
SMC
7.5 2
3q 48q 195 = 150
3.9
dSMC 7.5
(6q 48)
dq
3.9
dSMC
dq
dSMC
dq
7.5
(6(3) 48) 0
3.9
7.5
(6(13) 48) 0
3.9
q 3
q 13
Hence q = 13
69
At q = 13 SAVC=
7.5 2
7.5 2
q 24q 195
13 24(13) 195 $100
3.9
3.9
7) A perfect competitive firm operates in the short-run with labour as its only variable
factor. Its production function is X= -L3 = 10L2 +88L where X is output per week,
measured in tone, and L is the number of workers employed.
a)
The weekly wage is $324 and the product sells for $3.24 per ton. How many
workers should the firm employ to maximize profit?
b)
c)
The price of the product now rises $4 per ton with no change in the wage rate. By
how much does the firms maximum pure profit increase?
Calculate the firms are elasticity of supply of the product over the range of price
d)
If the price of the product remains at $4.00, but the weekly wage increase to
$480.00, how much output should the firm product to maximize profit?
Solution
a)
w
, where..MPP1 APP 1
p
3L 20 L 88
3.24
3.24
3L2 20L + 12 = 0
2
OR L = 6
3
L=6
70
dL w
w
, but from a) MPP1 w pMPP1
dw L
p
Also p = $3.24
w3.24(3L2 20L 88)
dw
19.44 L 64.8
dL
dL
1
dw 1944 L 64.8
elasticity of demand for labour is -1.04167
c)
w
L
3L 20 L 88
324
81
4
-3L + 20L + 7 = 0
L
1
3
OR L = 7
Q2 Q1 P1 P2
,
P2 P1 Q1 Q2
71
Are elasticity =
MPP1
w
, w $480, p $4
l
3L2 20 L 88
480
120
4
3L 20L + 32 = 0
8
L ..OR..L 4 L 4
3
At L = 4, MPP1 = 120
APP1 = -L + 10L + 88 = - (4) + 88 = 112
MPP1 . APP1 , thus stage 1
Hence the firm closes down and its output is zero.
A production function is said to be homogeneous if when each input factor is
multiplied by a positive real constant K, the constant can be completely factored out.
Mathematically, a function Z =f(x,v) is homogeneous of degree n if for all positive
real values of k. f(kx,kv) = K f(x,v) i.e
1) 8v, 9v is homogeneous of degree 1 because f(kx,kv) =8kx = 9kv = k(8x+9y)
2) Z = x2 + xy + y is homogeneous of degree 2 because
z=
2x
is homogeneous of degree o because
y
f (kx, ky)
5
2x 2x
2kx
k 0
ky
y y
72
= k3 x3 + 2k2 xy = k3 y3
= k 2 kx3 2 xy ky3
Question 7
Given the profit function = 160x 3x2 2xy 2y2 + + 120 - 18
For a firm producing to goods x and y,
a) Maximize profits
b) Test the second-order condition and
c) Evaluate the function at the critical values x and y
Solution
d
y 2 x 4 y 120
dy
Set and m equal to zero and solve simultaneously for x and v
160 6x 2y = 0
3x + y = 80 (1)
-2x 4y + 20 = 0
X + 2y = 60 . (2)
From 1) and 2)
X = 20 y = 20
b)
xx
d 2
6
d 2
yy
d 2
4
d 2
xx
d 2
d d
2
dxdy dx dy
is maximized at x = 20 and y = 20
c) = 160x -3x2 -2xy 2y2 + 120y 18
73
when x = 20 and y = 20
TUTORIAL SHEET
1) A monopolist sells two goods x and y for which the demand functions are
X = 25 = 0.5 Px, y = 30 Py and the combined cost function is C = x2 + 2xy + y2 20
Find a) the profit-maximizing price for each good
c)
d)
i)
Q = x2 + 6xy + 7y2
ii)
iii)
3x 2
5y2
74
Note
7) A monopolists production function and the factor prices that he must pay are such
that he can produce any output at a constant level of average cost $5 per unit. He
sells his product in two distict markets between which price discrimination is
possible. The demand curves in the two markets are given by the equations:
Q1 = 55 = P1,Q2 = 70 2P2
The monopolist maximizes his total pure profit. Calculate
a) The total output
b) The quantity sold in each market
c) The price in each market
d) The monopolists total profit
8)
A monopolist sells his output in two distinct markets between which price
discrimination is possible. His total costs and the demand curves are given by the follwing
equations: TC = 8Q + 100,Q1 = 10 0.5P1,Q2 = 40 P2
9)
A firm produces a single product X, from two factors, A and B. The factor prices are
75
d) = 1 and = o.5 and B = 20, derive equations for short-run variable cost, and short
run average variable cost, and short run marginal cost:
If 1 and = 0.5 B = 20, Pa=4 and Pb
e) = 9 at what output of X is the firm in possible long-run equilibrium?
10)
Find the equilibrium price and quantity for the following markets:
Qx + 32 7P = 0 and Qd 128 + 9P = 0
d) 13P Qx = 27 and Qd + 4P 24 = 0
76