Econ 50: Modified Section 9

November 20, 2015

1 Clarification

1. Homework problems
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(a) Quasilinear production function Q = F (L, K) = 20L 2 +K. Solve for K (w, r, Q),
L (w, r, Q), T C(w, r, Q) and sketch the total cost curve. (Also remember to verify
Shephards Lemma piece-wisely.)

(b) Intuition on perfect complements (not able to substitute).

(c) Plot of TC in the short run.

2. Envelope theorem

T C(w, r, Q) = wL (w, r, Q)+rK (w, r, Q), (w, r, P ) = P Q (w, r, P )(wL (w, r, P )+rK (w, r, P ))

A substantial part of these notes is based on notes from a previous TA. These notes are at best a
summary of the section. They are not intended to and will not serve as a substitute to attending the section.

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 T C(w,r,Q)
Shephards Lemma: w = L (w, r, Q), T C(w,r,Q)
r = K (w, r, Q).
(w,r,P )
Hotellings Lemma: P = Q (w, r, P ), (w,r,P
w
)
= L (w, r, P ), (w,r,P
r
)
=
K (w, r, P ).

3. Zero economic profit: homogeneity (what if control of key inputs?)

4. Profit maximization v.s. cost minimization: Profit maximization entails cost mini-
mization.

max (Q, L, K) = max {T RT C} = max max{P QT C(L, K, Q)} = max{P Qmin T C(L, K, Q)}
Q,L,K Q,L,K Q L,K Q L,K

5. To celebrate Thanksgiving, I prepared some small gifts for you (Econ 50 Summary
Notes Part 1), so if you have time

(a) Go through the summary notes very carefully, with special focus on the examples.
(b) Go through as many practice problems in the section notes as possible (probably
in reverse order).

Happy Thanksgiving to all of us!!!

2 Practice Exam Question

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Practice exam question: Individual and market supply in the SR and LR

Smiths is a firm that manufactures widgets in the township of Lincoln. Because manufacturing
widgets pollutes the local stream, Smiths needs to buy a permit from the local
council in order to produce a positive quantity. The permit is valid for one year, is nonrefundable
and non-transferable. It costs CP=$5

In addition to the permit, to produce Smiths requires capital (K), which can be rented at rate r in
unlimited quantities, and labour (L), which can be hired in unlimited quantities at cost w per
man-hour. Smiths production function is F(L,K)=5!.! !.! .

A) This year (2013) Smiths has already purchased a permit and has signed an agreement to rent
= units of capital for the year.

Write down Smiths profit maximization problem for 2013, given that the market price of
widgets is P. Solve Smiths profit maximization problem to find the expression for Smiths short
run (2013) labor demand, !" (, , , ).

B) In 2013, there are 100 widget-manufacturing firms in Lincoln, all identical to Smiths. All
have already bought their permits and are constrained to use levels of capital = 4 in 2013.
Suppose in 2013 the wage w is 1 and the rental rate for capital, r, is 4. Furthermore, market
!""
demand for widgets is given by ! = ! . Write the equation for market supply of widgets in
2013 and find the equilibrium price and market quantity. Are the firms making positive, negative
or zero economic profits?

C) In 2014, wages and capital rental rates are expected to remain at their 2013 levels. Smiths
has to decide whether to buy a permit to produce widgets for 2013, and if it chooses to produce,
what levels of capital and labor to use. Both can be chosen freely. Assume the price of a
permit is still CP=$5. Write down Smiths profit maximization problem for 2014, assuming the
price of widgets will be P. Solve for Smiths labor demand !" (), capital demand !" (), and
supply function !" (). What is Smiths long run shut-down price?

!""
D) Assume market demand is still given by ! = ! in 2014 and firms are free to enter and exit
the widget industry between 2013 and 2014. What will the equilibrium price and market
quantity be in 2014? How many firms will operate in 2014? What will the economic profit of
each firm be for 2014? You may assume any changes in the number of firms do not alter the
wage rate or capital rental rate.
3 Practice Exam Question: Solutions

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