Problem Set 7

Econ 613(01) Spring 2003

(Dr. Tin-Chun Lin)
1
1. The Company Z digs ditches. It faces the production function, Q  L2 K , where Q is
the number of ditches dug, L is hours of labor, and K is the number of digging tools.
a. Complete the following table:
K=0 K=1 K=2 K=3
L=0
L=1
L=2
L=3
b. Does the production function display increasing, decreasing, or constant returns to
scale? Explain.
c. Are the marginal products of K and L increasing, decreasing, or constant?
Explain.
d. Assume constant input prices. Draw the general shapes of the following: (1) long-
run average cost, (2) short-run marginal cost, assuming L is fixed, (3) short-run
marginal cost, assuming K is fixed.

2. Suppose that labor is supplied by individual workers acting competitively. In some

markets, however, the supply of labor is determined by a union of workers.
a. Explain why the situation faced by a labor union may resemble the situation faced
by a monopoly firm.
b. The goal of a monopoly firm is to maximize profits. Is there an analogous goal
for labor unions?
c. Now extend the analogy between monopoly firms and unions. How do you
suppose that the wage set by a union compares to the wage in a comparative
market? How do you suppose employment differs in the two cases?
d. What other goals might unions have that make unions different from monopoly
firms?

3. Suppose the cost function of firm A, which produces two goods, is given by:
C  100  0.5Q1Q2  Q12  Q22 . The firm wishes to produce 5 units of good 1 and 4
units of good 2.
a. Do cost complementarities exist? Do economies of scope exist?
b. Firm A is considering selling the subsidiary that produces good 2 to firm B, in
which case it will produce only good 1. What will happen to firm A’s costs if it
continues to produce 5 units of good 1?

4. A multiproduct firm’s cost function was recently estimated as:

C (Q1 , Q2 )  75  0.25Q1Q2  0.1Q12  0.2Q22 .
a. Are there economies of scope in producing 10 units of product 1 and 10 units of
product 2?
b. Are there cost complementarities in producing products 1 and 2?
 c. Suppose the division selling product is floundering and another company has
made an offer to buy the exclusive rights to produce product 2. How would the
sale of rights to produce product 2 change the firm’s marginal cost of producing
product 1?

5. The Amy Corporation produces 1,000 wood cabinets and 500 wood desks per year,
the total cost being $30,000. If the firm produced 1,000 wood cabinets only, the cost
would be $23,000. If the firm produced 500 desks only, the cost would be $11,000.
a. Calculate the degree of economies of scope.
b. Why do economies of scope exist?