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Technology Prot maximization

Exercises of Microeconomics

Technology and Prot Maximization (Ch. 1-2 Varian) Fabio Tramontana (University of Pavia)
slides available at: http://tramontana.altervista.org/teaching.html

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Exercises Micro

Technology Prot maximization

Outline

Technology Exercise 1.2 Exercise 1.3 Exercise 1.5 Exercise 1.9 Exercise 1.11 Prot maximization Exercise 2.3 Exercise 2.4 Exercise 2.5 Exercise 2.7
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1.2 1.3 1.5 1.9 1.11

Outline

Technology Exercise 1.2 Exercise 1.3 Exercise 1.5 Exercise 1.9 Exercise 1.11 Prot maximization Exercise 2.3 Exercise 2.4 Exercise 2.5 Exercise 2.7
Tramontana Exercises Micro

1.2 1.3 1.5 1.9 1.11

Exercise 1.2

What is the elasticity of substitution for the general CES / technology y = a x + a x when a = a ?
1 1 1 2 2 1 2

Let us start by recalling that the elesticity of substitution measures the curvature of an isoquant and can be calculated as:
=

TRS d (x /x ) (x /x ) dTRS
2 1 2 1

or, by using the logarithmic derivative:

=

d ln(x /x ) d ln |TRS |
2 1

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1.2 1.3 1.5 1.9 1.11

Solution

We rst need to calculate the technical rate of substitution (TRS). Remember that:

TRS =
in our case: 1 f = xi from which: 1

f / x1 f / x2

ax
1

+ a2 x2

a x
i i

for i = 1, 2

a TRS = a
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1 2

x x

1 2

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1.2 1.3 1.5 1.9 1.11

Solution

so that:

x x
and taking logs: ln

2 1

TRS

a 1 a
2 1

x x

2 1

ln |TRS | + ln

a a

2 1

and we can apply the denition:

=

d ln(x /x ) 1 = . d ln |TRS | 1
2 1

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Exercises Micro

1.2 1.3 1.5 1.9 1.11

Outline

Technology Exercise 1.2 Exercise 1.3 Exercise 1.5 Exercise 1.9 Exercise 1.11 Prot maximization Exercise 2.3 Exercise 2.4 Exercise 2.5 Exercise 2.7
Tramontana Exercises Micro

Exercise 1.3

Dene the output elasticity of a factor i to be

i (x ) =
a 1 b 2

f (x) xi xi f (x)

If f (x) = x x , what is the output elasticity of each factor? Let us rst calculate the partial derivative of the production function with respect to the factor x :
1

f (x) a1 b = ax1 x2 x1
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Solution

from which we have that:

1 (x ) = f (x) x1 = x1 f (x)

ax x xx
a 1 a 1

b 2

b 2

=a

and with a similar reasoning:

2 (x ) = f (x) x2 = x2 f (x)

bx x xx
a 1 a 1

b 2

b 2

= b.

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1.2 1.3 1.5 1.9 1.11

Solution

Note that the same elasticity can be calculated through the following alternative denition:
i (x ) =

d ln f (x) d ln x
i b a b 2 1 2

In our case we have that: ln f (x ) = ln x x = ln x + ln x that is ln f (x ) = a ln x + b ln x and nally:

a 1 1 2

1 (x ) =

d ln f (x) =a d ln x
1

; 2 (x ) =

d ln f (x) =b d ln x
2

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Exercises Micro

1.2 1.3 1.5 1.9 1.11

Outline

Technology Exercise 1.2 Exercise 1.3 Exercise 1.5 Exercise 1.9 Exercise 1.11 Prot maximization Exercise 2.3 Exercise 2.4 Exercise 2.5 Exercise 2.7
Tramontana Exercises Micro

Exercise 1.5

1 2

Let us start by recalling that the elesticity of scale is dened as:

e (x) =
or:

dy (t ) t dt y

=1

e (x) =

df (t x) t dt f (t x)

=1

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Solution

For the CES function we have that:

f (t x) = (tx
that is:

) + (tx2 )

=t

x + x
1 2

f (t x) = tf (x).
The CES function exhibits constant returns to scale. In particular:

e (x) =

df (t x) t dt f (t x)

=
t

=1

= 1.
t

=1

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1.2 1.3 1.5 1.9 1.11

Solution

Again, we should obtain the same result by using logarithms. The elasticity of scale can be written as:

e (x) =
In our case: so:

d ln f (t x) d ln t

=1

1 ln f (tx ) = ln t + ln x + x

1 2

e (x) = 1.
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1.2 1.3 1.5 1.9 1.11

Outline

Technology Exercise 1.2 Exercise 1.3 Exercise 1.5 Exercise 1.9 Exercise 1.11 Prot maximization Exercise 2.3 Exercise 2.4 Exercise 2.5 Exercise 2.7
Tramontana Exercises Micro

1.2 1.3 1.5 1.9 1.11

Exercise 1.9

Consider the CES technology f (x , x ) = a x + a x that we can always write this in the form f (x , x ) = A( ) bx + (1 b)x / .
1 2 1 1 2 2 1 2 1 1 2

. Show

We need to use some algebraic trick in order to solve the problem. Let us multiply the parameters a and a by
1 2

a a

+ a2 = 1: 1 + a2
1

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Solution

f (x , x
1

) = (a1 + a2 )

a
1

+ a2

x +
1

a
1

1
2

+ a2

x
2

1

a
1

+ a2

= 1

a
1

+ a2

we can nally have:

1

f (x , x
1

) = A( )
1

where A( ) = (a + a )
2

bx + (1 b)x a and b = . a +a
1 2 1 1 2

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Exercises Micro

1.2 1.3 1.5 1.9 1.11

Outline

Technology Exercise 1.2 Exercise 1.3 Exercise 1.5 Exercise 1.9 Exercise 1.11 Prot maximization Exercise 2.3 Exercise 2.4 Exercise 2.5 Exercise 2.7
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1.2 1.3 1.5 1.9 1.11

Exercise 1.11

For each input requirement set determine if it is regular, monotonic and/or convex. Assume that the parameters a and b and the output levels are strictly positive. Remember that a input requirement set is regular provided that V (y ): closed (it must include its own boundary) non-empty (each positive level of output can be produced)

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(a) V (y ) = {x , x : ax log y , bx log y }

1 2 1 2

This is a case in which the isoquants look like the isoquants of the Leontief technology. The main dierence is that output is measured in terms of log y :

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Solution

As for the Leontie technology, V (y ) is closed, non-empty (regular), monotonic and convex.

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Exercise 1.11 (b)

(b) V (y ) = {x , x : ax + bx y , x > 0}
1 2 1 2 1

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Solution

It follows that V (y ) is non-empty but not closed, so it is not regular. In fact: you can produce the quantity y with combinations of inputs in which x is arbitrarily low, but not equal to 0. So the input requirement set does not contain one of its boundaries.
1

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Exercise 1.11 (c)

(c) V (y ) = x , x : ax + x x + bx y
1 2 1 1 2 2

It is immediate to see that in this case V (y ) is regular. In order to prove monotonicity we must calculate the rst derivatives:
f (x1 ,x2 ) x1 f (x1 ,x2 ) x2
2 0 = a + 2x x1 x2 1 = b + 2x 0 x1 x2

so V (y ) is monotonic.

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1.2 1.3 1.5 1.9 1.11

Solution

To prove that the isoquants are convex, it is sucient (but not necessary) to show that the production function is concave. We need to calculate the Hessian matrix, so we need the second derivatives:
f (x1 ,x2 ) 2 x1 f (x1 ,x2 ) x1 x2

= 1 x 4 1 =
1 4 1

3 2

x x

1 1 2 2
2

x2
2

f (x1 ,x2 ) x1 x2 f (x1 ,x2 ) 2 x2

x2 x2 1 3 = x2x 2
=
1 4 1 2 1 4 1 2

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Solution

The principal minors are:

D D

= 1 x 2 x22 < 0 4 1 1 1 1 1 1 1 x2 16 x1 x2 = 0 2 = 16 x1

so the Hessian matrix is semi-denite negative, the production function is concave and the input requirement set is convex.

Tramontana

Exercises Micro

2.3 2.4 2.5 2.7

Outline

Technology Exercise 1.2 Exercise 1.3 Exercise 1.5 Exercise 1.9 Exercise 1.11 Prot maximization Exercise 2.3 Exercise 2.4 Exercise 2.5 Exercise 2.7
Tramontana Exercises Micro

2.3 2.4 2.5 2.7

Exercise 2.3

Calculate explicitly the prot function for the technology y = x , for 0 < a < 1 and verify that it is homogeneous and convex in (p , w ).
a

We know (also from the Example in the text) that the rst-oder condition is given by:

pax

= w,

while the second-order condition is satised when a 1. By expliciting x we obtain the factor demand function:

x (p , w ) =
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w a1 ap
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2.3 2.4 2.5 2.7

Solution

The supply function is obtained by putting the factor demand function into the production function:

y (p, w ) = f (x (p, w )) =

w a1 , ap

from which we nally have the prot function:

(p , w ) = py (p , w ) wx (p , w ) = p
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w a1 w a1 w . ap ap

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Solution

Let us prove homogeneity:

(tp , tw ) = tp

w a1 w a1 tw = t (p , w ), ap ap

then the prot function is homogeneous of degree 1. In order to prove convexity, it remains useful to see the prot function as follows:
(p , w ) = p 1a w a1
1
a

a 1a a 1a

= p 1a w a1 (a),

with (a) is strictly positive, provided that 0 < a < 1.

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Solution

The Hessian matrix is dened as:

2 (p , w ) p2 D 2 (p, w ) = 2 (p , w ) wp 2 (p , w ) p w 2 (p , w ) w2
a

that in our case is:

=

p 1a w a1 a 1 ( )2 p 1a w a1
(1a)2
a 1 a a

2a1

a (1 p 1a w a1 a)2

(1a)2

p 1a w a1

2a

(a ),

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Solution

whose principal minors are:

1 =
(1a)2
a

p 1a w a1 (a) > 0

2a1

, 2 = 0 .

So, the Hessian matrix is a positive semidenite matrix and:

(p , w ) is convex in (p , w ).

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Exercises Micro

2.3 2.4 2.5 2.7

Outline

Technology Exercise 1.2 Exercise 1.3 Exercise 1.5 Exercise 1.9 Exercise 1.11 Prot maximization Exercise 2.3 Exercise 2.4 Exercise 2.5 Exercise 2.7
Tramontana Exercises Micro

2.3 2.4 2.5 2.7

Exercise 2.4

Let f (x , x ) be a production function with two factors and let w and w be their respective prices. Show that the elasticity of the factor share (w x /w x ) with respect to (x /x ) is given by 1/ 1.
1 2 2 2 2 1 1 1 2

Let us note that in logarithms the mentioned elasticity is calculable as follows: d ln(w x /w x ) , d ln(x /x ) but by using the properties of logarithms we have that:
2 2 1 1 1 2

2 2 1 1 1 2 1 2

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2.3 2.4 2.5 2.7

Solution

Therefore,

d ln(w x /w x d ln(x /x )
2 2 1 1 2

d ln(w /w ) 1. d ln(x /x )
1 2 2 1

|TRS | =
f x1 f x2

w w

1 2

1 2 2 1 2 1

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Solution

but

1

1 2

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2.3 2.4 2.5 2.7

Outline

Technology Exercise 1.2 Exercise 1.3 Exercise 1.5 Exercise 1.9 Exercise 1.11 Prot maximization Exercise 2.3 Exercise 2.4 Exercise 2.5 Exercise 2.7
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Exercise 2.5

Show that the elasticity of the factor share with respect to (w /w ) is 1 .

2 1

The elasticty of the factor share with respect to (w /w ) can be calculated as follows:
2 1

d ln(w x /w x d ln(w /w )
2 2 1 2 1

) .

2 2 1 1 2 1 2 1

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2.3 2.4 2.5 2.7

Solution

so we have that:

d ln(w x /w x d ln(w /w )
2 2 2 1 1

d [ln(w /w ) + ln(x /x d ln(w /w )

2 1 2 2 1

)]

= 1

d ln(x /x ) , d ln |TRS |
2 1

and nally:

d ln(w x /w x d ln(w /w )
2 2 1 2 1

= 1.

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Exercises Micro

2.3 2.4 2.5 2.7

Outline

Technology Exercise 1.2 Exercise 1.3 Exercise 1.5 Exercise 1.9 Exercise 1.11 Prot maximization Exercise 2.3 Exercise 2.4 Exercise 2.5 Exercise 2.7
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Exercise 2.7 (a)

The production function is f (x ) = 20x x and the price of output is normalized to 1. Let w be the price of the x input. We must have x 0. (a) What is the rst-order condition for prot maximization if x > 0?
2

We know that:
(x ) = f (x ) wx = 20x x 2 wx

from which we obtain the rst-order condition:

(x ) = 20 2x w = 0.
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Exercise 2.7 (b)

(b) For what values of w will the optimal x be zero? From the previous point we know that the optimal level of input is given by: 20 w x = 2 which is equal to zero provied that:

w = 20
but also if w > 20, in fact the input level cannot be negative.
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Exercise 2.7 (c)

(c) For what values of w will the optimal x be 10? We must solve:

x =
from which:

20 w = 10 2

w = 0.

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Exercise 2.7 (d)

(d) What is the factor demand function? The factor demand function comes from the rst-order condition by expliciting x : 20 w w x= = 10 2 2 but given the physical restriction concerning the non-negativity of the input's level we should write:

x = max {10 w /2, 0} .

Tramontana Exercises Micro

Exercise 2.7 (e)

(e) What is the prot function? The prot function is a function of prices. Until now we have:
(x , w ) = 20x x 2 wx = (20 w x )x

(w ) =

10

w
2

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Exercise 2.7 (f)

(f) What is the derivative of the prot function with respect to w ? From the prot function obtained in the previous point we can easily calculate the derivative:
(w ) = 2 10

w
2

1 2

that is:
(w ) = 10

w
2

which is the negative of the factor demand, as we should expect.

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