MANAGERIAL ECONOMICS- ECON 2210

Exercise 3 (25 marks)

1. The production function for a factory producing headphones is given by the following:
Q = 3L1/2K1/2

Where Q is the units of headphones produced; K is the units of capital used in production; and L
is the units of labour.

The factory hired labour at $12 per unit and capital at $24 per unit. The headphones that the
factory produced are sold in the market for RM20 per unit.

(i) If the factory decides to keep capital fixed at 4 units, determine the level of labour
that the firm should hire to maximize profits? (6 marks)
(ii) Based on your answer in part (i) above, what will be the total level of output and
profits of the factory? (3 marks)

2. A firm has a total cost function given by:

C(Q) = 400 + 40Q – 4Q2 + 0.25Q3

i. Derive the total variable cost and the average variable cost functions. (3 marks)
ii. If this firm is a price taker, what is the minimum market price for the firm’s product before it
considers shutting down? (3 marks)

3. You are the operation manager of Putera Design which operates in a purely competitive
market for ‘batik’ shirts. Your production department has provided you with the following cost function;

C(Q) = 125 + 4Q2

Where Q is the number of ‘batik’ shirts produced.
(i) If other firms charge RM40 per unit, what level of price that you should charge
for your ‘batik’ shirts? Why? (2 marks)
(ii) How much you should produce in order to maximize profits (or minimize losses)?
What will be your level of profits (or losses)? (3 marks)
(iii) Based on your answer in part (ii), what will be the likely effect on your profits(or
losses) in the long run? (3 marks)

4. You would like to increase your market share and profits through advertising your
products more effectively. You have estimated that the own-price elasticity of demand for your
company’s product is -4.5 and the advertising elasticity of demand is 1.5. Assuming these
elasticities are constant, what proportion of the company’s revenues should you spend on
advertising to maximize profits? (2 marks)