Question

18. Supposex, and x2 are used in fixed proportions such that y = mink,,2x2). At the point x1 = x2 = 4, the MPs A. 1; 2 and the MP2 is C. 0; 1 D. 2; 0 E. 0; 2 19. A competitive firm has a production function Y= 2L + 10K. If w = $2 and r= $8, what will be the minimum cost of producing 50 units of output? A. $40*** B. $50 C. $45 D. [None of the above]

Answer 1

Solution:

18. At the kink, x1 = 2*x2, the point given is x1 = x2 = 4

The given point gives utility = min{4, 2*4} = min{4, 8} = 4

Notice, that with x1 = 4, increasing x2 any beyond 2 (as at kink 4 = 2*x2 , so x2 = 2) will not increase the utility. So, marginal utility from good 2 is 0 (if you increase x2 by 1 more unit, so x2 = 5, utility is still 4). Notice, however increasing good 1 by 1 unit, will generate utility = 5, so marginal change in utility due to an additional consumption of good 1 is 1. Thus, correct option is (B) 1; 0

19. With production function of Y = 2L + 10K, L and K act as perfect substitutes in production of Y. Note that marginal product of labor, MPL = 2 and marginal product of capital, MPK = 10, so marginal rate of technical substitution = MPL/MPK = 2/10 = 0.2

Now, wage to rental rate ratio = w/r = 2/8 = 0.25

Clearly, wage to rental rate ratio = 0.25 > 0.20 = MRTS, implying that relative marginal cost of hiring labor is more than relative marginal benefit of labor (or in other words, relative marginal cost of hiring capital is lower than relative marginal benefit of hiring capital). So it would be beneficial to hire only the capital (since capital and labor are perfect substitutes in production).

Thus, for Y = 50, using the production function, we have 50 = 10*K, K = 5

Total cost = w*L + r*K

TC = 2*0 + 8*5 = $40

So, correct option is (A) $40.