STUDENT NAME: ________________________

STUDENT ID: ________________________

ECON 2020/50 Principle of Microeconomics - Fall 2018

Assignment 02 (20 points)

Due Date: December 04, 2018

1. (TOTAL: 5 points). GMC is producing cars using machines (K) and labor (L). The
technology is capital intensive; the production function is given by

Assume that in the long-run, GMC produces cars according the following table:

Y K L

3 1 10
6 2 12
9 3 14
11 4 16
14 5 18
17 6 20
20 7 22
23 8 24
26 9 26
30 10 28
33 11 30
36 12 32
40 13 34
43 14 36
47 15 38
51 16 40
54 17 42
58 18 44
62 19 46
66 20 48
a) Prepare an Excel spreadsheet and use the data from the above Table to estimate
the coefficient and β. Re-write the production function for GMC.

α=?β=?

b) Assume that the value of GMC physical capital (machines, real estate etc.) is
equal to K =$16 billon (in calculations ignore billions), and suppose the price of a
car is equal to p and the wage rate is w (parameters).

i. Write down the profit as a function of L.

ii. Are we considering a short-run or a long-run?

c) Using your Excel spreadsheet, create a graph with L on the horizontal axis and $
on the vertical axis, plot two components of profit function: total revenue
(pF(K;L)), and labor cost (wL) (when drawing, assume p = 1 and w = 2).
Assume L belongs to the interval (0;20).
(Copy and paste your plot from Excel).
d) Derive a formula for the marginal products of labor and calculate it on your Excel
spreadsheet. Plot your MP_L. (Copy and paste your plot from Excel).

e) Find analytically the optimal level of labor L* that maximizes the profit as a
function of the real wage w/p. (Re-call it the firm’s labor demand). Find the value
of L for the following values of parameters:

P 1 1 1
w 8 4 2

Plot your demand for labor on the graph with the real wage (w/p) on the vertical
axis and L on the horizontal one. Using the table, mark three points corresponding
to the three values of (w/p).
f) What is the maximal profit for each of the three (w/p) values? Use the above table a
plot your results. (Copy and paste your plot from Excel).
2. (TOTAL: 5 points). Consider the following production functions:

i.
ii.
iii.

a) What is the returns to scale for each function (use formal argument with λ)?
Assume that = =1

b) Find the cost functions for each of the production functions.

c) Plot the cost function on the same graph with y on the horizontal axis and cost on the
vertical one.
 d) Find and plot the average and marginal cost functions with y on the horizontal axis
and average cost and marginal cost on the vertical one.
3. (TOTAL: 5 points). The GMC company is considering building a new car factory in
China. The total (fixed) cost of the investment is F = 4. When built, the factory will allow
to produce y cars at the (variable) cost given by

a) Does the technology used in the new factory exhibit increasing, decreasing or
constant returns to scale (ignore the fixed costs in this point)?

b) Find a total costs (TC) of producing 1, 2 and 4 cars. Use an Excel spreadsheet to
plot the graph (y; COST) plot a TC curve, and decompose it into a fixed cost
curve and a variable cost curve by adding the two curves to your graph. (Hint:
increase output units by 0.1)
c) Find the values of the average fixed cost (AFC) for three levels of production y =
1, 2 and 4. Plot an AFC curve in a separate graph. What happens to the AFC when
production becomes very large (close to infinity) and when it is very small (close
to zero). Explain.

d) Find the values of the average variable cost AV C for y = 1, 2 and 4, and mark
them in the graph from question c). Connect the three points to obtain the AV C
curve.
e) Find the values of the average total cost ATC for y = 1, 2 and 4 and mark them in
your graph from c). Connect the three points to obtain the ATC curve. What are
the values of ATC when the production is very small and very large? Explain
which of the two components of ATC - AFC or AV C-dominates in each of the
two extremes. Why?

f) Find analytically the minimal efficient scale (MES), , for the

considered car technology.
g) Find analytically the marginal cost MC curve. In a new graph plot the MC curve,
together with the ATC, marking the MES.

h) Explain intuitively why or why not the MC curve cuts or does not cut the ATC
curve at the MES.
i) Harder: find analytically a minimal efficient scale yMES, and ATCMES as a
function of F (parameter). How do the two values depend on the level of F?
4. (TOTAL: 5 points). Benjamin is fortunate enough to be the only producer in the market.
He faces a demand curve:

P = 20 – 3Q

and his costs are given by

C = 2Q.

a. Suppose Benjamin behaves competitively. Find the equilibrium industry price and
quantity.

b. Benjamin realizes he is the only producer and decides to start behaving like a
monopolist. Find the monopolist’s choice of price and quantity.

c. On a graph, draw the supply, demand, and marginal revenue curves, and label the
equilibrium prices and quantities under perfect competition and monopoly. Calculate the
producer and consumer surplus in each case. What is the deadweight loss associated with
the monopoly?

d. Suppose the government wants to induce Benjamin to produce the efficient quantity by
introducing a quantity tax. Each unit he produces are taxed at t, so that his profit function
is given by [P(Q)-t]Q – 2Q, where P(Q) is the market demand curve. Find Benjamin’s
production as a function of the tax. What tax leads to the same quantity as in the
competitive equilibrium? What is the intuition for this result?