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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
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## 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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## 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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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
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## 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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## 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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## 1.2 1.3 1.5 1.9 1.11

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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## 1.2 1.3 1.5 1.9 1.11

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.

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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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## 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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## 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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## 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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## 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} .

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## 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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