Technology Prot maximization

Exercises of Microeconomics

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

PhD in Economics at L.A.S.E.R.

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Exercises Micro

Technology Prot maximization

Outline

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

Exercise Exercise Exercise Exercise Exercise

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 Prot maximization Exercise 2.3 Exercise 2.4 Exercise 2.5 Exercise 2.7
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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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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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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 denition:

=

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

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Exercise Exercise Exercise Exercise Exercise

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Outline

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

Dene 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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Solution

Note that the same elasticity can be calculated through the following alternative denition:
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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Technology Prot maximization

Exercise Exercise Exercise Exercise Exercise

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 Prot maximization Exercise 2.3 Exercise 2.4 Exercise 2.5 Exercise 2.7
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Exercise 1.5

What is the elasticity of scale of the CES technology x + x

1 2

Let us start by recalling that the elesticity of scale is dened 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

dtf (x) t dt tf (x)

= 1.
t

=1

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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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Exercise Exercise Exercise Exercise Exercise

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Outline

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

(a + a )a (a1 + a2 )a2 f (x1 , x2 ) = 1 2 1 x1 + x a1 + a2 a1 + a2 2

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Solution

Now we can write:

f (x , x
1

) = (a1 + a2 )

a
1

+ a2

x +
1

a
1

1
2

+ a2

x
2

and by noting that

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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Exercise Exercise Exercise Exercise Exercise

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Outline

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

(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 dierence 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

In this case the isoquants have the following shape:

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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

V (y ) is also monotonic and convex.

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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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Solution

To prove that the isoquants are convex, it is sucient (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

that are the elements of the Hessian matrix.

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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-denite negative, the production function is concave and the input requirement set is convex.

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Exercise Exercise Exercise Exercise

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Outline

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

Calculate explicitly the prot 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 satised 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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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 prot 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 prot function is homogeneous of degree 1. In order to prove convexity, it remains useful to see the prot 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 dened 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 semidenite matrix and:

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

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Technology Prot maximization

Exercise Exercise Exercise Exercise

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Outline

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

ln(w x /w x ) = [ln(w /w ) + ln(x /x )] .

2 2 1 1 1 2 1 2

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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

Now, from the prot maximization condition we obtain that:

|TRS | =
f x1 f x2

w w

1 2

so the formula of the elasticity can be written as:

d ln |TRS | d ln(w /w ) 1 = 1 d ln(x /x ) d ln(x /x )

1 2 2 1 2 1

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Solution

but

nally we have that the required elasticity is given by: 1

1

d ln |TRS | is the inverse of the elasticity of substitution , so d ln(x /x )

1 2

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Outline

Technology Exercise 1.2 Exercise 1.3 Exercise 1.5 Exercise 1.9 Exercise 1.11 Prot 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

) .

From Exercise 2.4 we know that: ln(w x /w x ) = [ln(w /w ) + ln(x /x )] ,

2 2 1 1 2 1 2 1

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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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Technology Prot maximization

Exercise Exercise Exercise Exercise

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 Prot 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 prot 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} .

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Exercise 2.7 (e)

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

but now we can use the optimal level of input to obtain:

(w ) =

10

w
2

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Exercise 2.7 (f)

(f) What is the derivative of the prot function with respect to w ? From the prot 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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