Econ 50: Modified Section 6

October 30, 2015

1 Administration

1. Problem set 5 (mid-term evaluation) due tonight.

2. Midterm and suggestions (go over lecture notes and carefully derive practice problems
yourself after each section).

2 Production Functions

Consider a production function Q = F (L, K). While the level of U does not matter for
consumer theory (any positive monotonic transformation represents the same preferences),
the level of Q matters in production. Four main concepts so far:

1. Marginal Product

2. Marginal Rate of Technical Substitution (MRTS)

3. Returns to Scale

4. Elasticity of Substitution (EOS)

Marginal product is similar to marginal utility in consumer theory, but has actual mean-
ing. MPL= F
L measures the incremental output for an additional unit of labor. Similar is
true for MPK. (Positive monotonic transformation will alter the value).
Marginal rate of technical substitution (MRTS) is essentially the same as marginal rate
MP L
of substitution (MRS) in consumer theory. MRTS= M P K measures the relative value of

A substantial part of these notes is based on notes from a previous TA. These notes are at best a
summary of the section. They are not intended to and will not serve as a substitute to attending the section.

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labor and capital (beware of the order). (Positive monotonic transformation will not alter
the value).
Returns to scale is a concept specific to producer theory. It measures how output changes
if we scale the inputs, i.e. we want to compare F (tL, tK)(t > 1) with tF (L, K). (Positive
monotonic transformation will alter the value).
The only difficult (and unimportant?) concept is elasticity of substitution (EOS). It
measures to what degree the inputs are substitutable for each other. To conform with
intuition, when inputs are perfect complements, EOS=0 and when inputs are perfect sub-
stitutes, EOS=. (Positive monotonic transformation will not alter the value).
We can calculate the EOS (denoted ) several ways:

%( K )
1. By definition: = %(M RTL
S) (Notice the order of K and L in the numerator is
different from that in MRTS).
1
2. Alternatively, we can re-arrange the terms: = dM RT S K/L
.
d(K/L) M RT S

As Professor Abramitzky mentioned, you are only required to calculate EOS in very spe-
cial cases: perfect complements, perfect substitutes and Cobb-Douglas (or positive mono-
tonic transfromation).
The definition is especially useful when % MRTS=0 or . Consider the cases of
perfect complements and perfect substitutes: F (K, L) = min{K, L}, F (K, L) = K + L.

2
 The alternative formulation is useful for the Cobb-Douglas case: F (L, K) = AL K .

MPL K
M RT S = =
MPK L

dM RT S
=
d(K/L)

1
= =1
dM RT S K/L
d(K/L) M RT S

3 Practice Exam Problem on Production Functions

For each of the following production function, sktech a representative isoquant curve. Cal-
culate the marginal product for each input, and indicate whether each marginal product
is diminishing, constant or increasing. Compute the marginal rate of technical substi-
tution and the elasticity of substitution. Finally, indicate whether the function exhibits
constant, increasing or diminishing returns to scale.

(a) F (L, K) = L2 K
1 1
(b) F (L, K) = L 3 K 6

(c) F (L, K) = (L + K)2

1
(d) F (L, K) = (L + K) 2

3
4 Suggested Solutions

(Isoquants Omitted)

(a) MPL= F F 2
L = 2LK (increasing in L), MPK= K = L (constant in K).
MP L K
MRTS= M PK = 2 L .
dM RT S 1
d(K/L) = 2, so = dM RT S K/L
= 1.
d(K/L) M RT S

Take any t > 1, F (tL, tK) = (tL)2 (tK) = t3 L2 K > tF (L, K), so increasing returns to
scale.
2 1 1 5
1 3
(b) MPL= F
L = 3 L
F
K 6 (decreasing in L), MPK= K = 61 L 3 K 6 (decreasing in K).
MP L K
MRTS= M P K = 2 L (notice its the same as (a)).
Given MRTS is the same, = 1.
1 1 1 1 1
Take any t > 1, F (tL, tK) = (tL) 3 (tK) 6 = t 2 L 3 K 6 < tF (L, K), so decreasing returns
to scale.

(c) MPL= F F
L = 2(L + K) (increasing in L), MPK= K = 2(L + K) (increasing in K).
MP L
MRTS= M P K = 1 (same as perfect substitutes).
Given MRTS is the same as perfect substitutes, || = (you can also use formulation
2 to verify).
Take any t > 1, F (tL, tK) = (tL + tK)2 = t2 (L + K)2 > t(L + K)2 , so increasing
returns to scale.
1 1
2
(d) MPL= F 1
L = 2 (L + K)
F
(decreasing in L), MPK= K = 12 (L + K) 2 (decreasing in
K).
MP L
MRTS= M P K = 1 (same as perfect substitutes).
Given MRTS is the same as perfect substitutes, || = (you can also use formulation
2 to verify).
1 1 1
Take any t > 1, F (tL, tK) = (tL + tK) 2 = t 2 (L + K) 2 < tF (L, K), so decreasing
returns to scale.