Minimizing Production Costs: Instructions

Lesson Description
In this lesson we combine information on a firm's production technology (Tutorial
7) with the prices of factor inputs to determine the firm's costs of production
(Tutorial 8). With that information we can explore how a firm decides how to
produce -- how many units of each input to employ.
Before you begin answering the questions or manipulating the model(s), read the Specific
Instructions for this workbook now. [If you haven't already done so, you should read the General
Instructions as well.]

General Instructions
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Specific Instructions for the Minimizing Production Costs Workbook

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The Production Function: Questions (Tutorial 7)

If you haven't done so already, read the Specific Instructions for this workbook now.
The following production function is written in Cobb-Douglas form:
Q(L,K) = A * L * K
where Q is the level of output, L = labor, and K = capital. The parameter A measures how
much output we would get if we used one unit of each input. The parameters and measure
how output responds to a one-unit change in either labor or capital.
In this exercise we will use the Isoquants worksheet to discover how changes in the
parameters of the Cobb-Douglas production function affect the location and shape of a given
isoquant. To start with, let the firm's output be fixed at Q = 100 units/t.

Short-Run Production
1.

Suppose that a firm currently has 100 machines hours (K) available for its production process.
Output per labor-hour when 100 machines are used is described by the production function:
Q(L | K) = -50 + 10*L - 0.02*L2
Given this production function, the marginal product of labor is described by:
MP(L) = 10 - 0.04*L
Create four columns in an Excel worksheet; L, Q(L | K), AP(L), MP(L).
Let the domain of L = 0, 20 . . . 300.
Fill in the remaining columns using the appropriate formulas for Q(L | K), AP(L), and MP(L).
Plot the average and marginal product curves. [Hint: Use graph type XY (Scatter).]

a.
b.
c.
d.
e. Use Solver to find L such that AP(L) is at a maximum. What is the average product of labor at
this input level? What is the marginal product of labor at this input level? See Sidebar.

Long-Run Production
2.

Changes in Technology:
Given this production function how do improvements in technology affect the productivity of K
and L? Explain. [Hint: Higher values of A indicate an improvement in technology.]
Changes in Relative Productivity:

3.
4.

Raise the value of parameter from 0.5, to 0.6, ... 0.9.

As rises relative to what happens to the shape of the isoquant? What does it reveal about
the relative productivity of Labor, L? Explain, using the concept of marginal rate of technical
Lower the value of parameter from 0.5, to 0.4, ... 0.1.
As rises relative to what happens to the shape of the isoquant? What does it reveal about
the relative productivity of capital, K? Explain, using the concept of marginal rate of technical
substitution.

Specific Instructions

Sidebar
a.
b.
c.
d.
e.

Q(L | K)

AP(L)

Number

Formula

Formula

Create a table similar to that shown above.

Under L, enter a positive integer, e.g., 10.
Under Q(L | K), write out the formula for total product Q(L).
Under AP(L), write out formula for AP(L)

Select Solver in the Tools menu.

f. Set cell with AP(L) formula to Max
by Changing cell with L number.

Minimizing Costs: Questions (Tutorial 8)

If you haven't done so already, read the Specific Instructions for this workbook now.

Costs in the Long Run

Select the "Isocosts" tab to answer the following question.
1)

For each of the next 6 events, answer the following three questions:
What happens to the y-intercept of the isocost line? Explain.
What happens to the x-intercept of the isocost line? Explain.
What happens to the slope of the isocost line? Explain.
a. w doubles;
b. w drops to half;
c. r doubles;
d. r drops to half;
e. w and r double;
f. w and r drop to half.

Select the "Cost Min." tab to answer the following 4 questions.

2)

Suppose w rises to $3/hr. Set up Solver to calculate the new cost-minimizing combination of L and K.
a. Explain what the equation in the "Target Cell" is calculating. Why is this the firm's "Objective"?
b. That "Target Cell" must be set "Equal to" the "Value of" __________. Why?
c. What Cell(s) must be changed for the "Target Cell" to reach the value noted in 2.b.? Why?
d. What "Constraint(s)" must be met when costs are minimized? Why?

3)

Suppose w increases to $5/hr. Set up Solver to calculate the new cost-minimizing combination of L and K.
Explain completely what happens to :
a. the isocost line;
b. the isoquant line;
c. K*;
d. L*.

4)

Reset parameters and calculations.

If the firm is currently employing L = 2 units and K = 12.50 units, are they producing Q = 100 units at the
lowest possible cost? Is yes, explain. If no, use the condition required for a cost-minimizing bundle to
describe what they should do.

5)

By drawing on a printout of the graph on the Cost Min. worksheet, compare the cost of increasing output to
Q = 150 units when:
a. K is fixed at 5 units and only L is allowed to vary; and
b. K and L are allowed to vary.
In case 5) b., use Solver to calculate the exact cost of producing the new level of output.

6)

Show (by drawing on a printout of the graph on the Cost Min. worksheet) the firm's expansion path as output
rises from 100 to 150 units.
274113232.xls

Tut. 8 Questions

Page 5 of 13

7)

How does an increase in the price of labor (to $4 per hour) change the firm's long-run expansion path?
Illustrate your explanation with a printout of the graph on the Cost Min. worksheet.

Costs in the Short Run

Open a new workbook in Excel.
8) Suppose a firm has a total cost function:
C(Q) = Q^3 - 13*Q^2 + 148*Q + 49
where MC(Q) = 3*Q^2 - 26*Q + 148
a. Create three columns in an Excel worksheet; Q, MC(Q), ATC(Q).
b. Let the domain of Q = 0, 0.5 ... 10.
c. Fill in the remaining columns using the formulas for MC(Q) and ATC(Q).
d. Plot the marginal and average total cost curves. [Use the "XY (Scatter)" charting style.]
e. At what level of output does the ATC(Q) curve reach its minum. [Use Solver to find the
minimum Q.] What is the marginal cost at this output level?
f. Explain why marginal costs increase as more output is produced (beyond Q = 4.5 units/t)?
g. If the marginal cost of production is increasing, does this tell you whether the average
variable cost is increasing or decreasing? Explain.

Mathemagical Extensions
9)

Suppose that a firm must pay an annual franchise fee, which is a fixed amount, independent of whether it
produces any output. Show mathemagically how this tax affects the firm's marginal and average costs in the
short run.

10) Instead, suppose the firm is charged a tax that is proportional to the number of items it produces. Again,
show mathemagically how this tax affects the firm's marginal and average costs in the short run.

274113232.xls

Tut. 8 Questions

Page 6 of 13

C a p ita l (h rs p e r d a y )

Isoquants

The Production Function (Isoquant)

Assumptions:
A = 20

0.5

Copyright 1997-99: Mark S. Walbert All rights reserved.

5
15.00

0.5

14.00
13.00

12.00

Q1 =

11.00

100

10.00
9.00

Q = A* L

8.00

where:

7.00

*K

6.00
5.00

6
7

4.00
3.00

10

2.00

11

12 13

14

15

1.00

16

0.00
0

Page 7

10

11

12

13

14

15

Labor (hrs per day)

Isoquants

Mark S. Walbert All rights reserved.

10

11

10

12 13

11

12

14

13

15

14

16

15

Labor (hrs per day)

Page 8

C a p ita l (h rs p e r d a y )

Isocosts

The Cost of Production (Isocost)

Assumptions:
w = $ 2.00

r = $ 2.00

Copyright 1997-99: Mark S. Walbert All rights reserved.

15.00

C1 = $

14.00

20

13.00
12.00
11.00

where:
C=w*L+r*K

10.00
9.00
8.00
7.00
6.00
5.00
4.00
3.00

2.00
1.00
0.00
0

Page 9

10

11

12

13

14

15

Labor (hrs per day)

Isocosts

Mark S. Walbert All rights reserved.

10

11

12

13

14

15

Labor (hrs per day)

Page 10

The Cost Minimizing Input Bundle

Assumptions:
w = $ 2.00

r = $ 2.00
Q1 =

C a p ita l (h rs p e r d a y )

Cost Min.

Copyright 1997-99: Mark S. Walbert All rights reserved.

15.00
14.00

100

13.00
12.00
11.00
10.00

Equilibrium
L* = 5.00 hrs per day
K* = 5.00 hrs per day
C1 = $ 20.00
Objective:
Constraint:

MPL =
MPK =

0
100

10.00
10.00

must equal zero

must equal Q1

9.00
8.00
7.00
6.00

5.00
4.00
3.00
2.00

15

1.00

0.00
0

11
6

10

11

12

13

14

15

Labor (hrs per day)

Page 11

Cost Min.

Walbert All rights reserved.

15
11
10

11

12

13

14

15

Labor (hrs per day)

Page 12

Cost Min Inputs

5.000000951
5.000003459

Page 13