Class Problem 4.1. (See “Problem Solved: What Skills Do We Need?”, p.

113 in the
textbook)

Consider the Beiswanger Company, a small firm engaged in engineering analysis.

Beiswanger’s president has estimated that the firm's output per month (Q) is related in the
following way to the number of engineers (E) and technicians used (T): Q = 20E – E2 + 12T
- 0.5T2.

The monthly wage of an engineer is $4,000 and the monthly wage of a technician is $2,000.
If the president allots $28,000 per month for the combined wages of engineers and
technicians, what mix of engineers and technicians should he hire?

SOLUTION: The objective is to maximize output per month Q, given a budget constraint
of $28,000 per month.

In order to determine the optimal number of engineers and technicians to employ, we need
to find the values for E and T at which the marginal products per dollar spent on engineers
and technicians are identical, i.e., we need to determine the values for E and T which cause
MPE / PE  MPT / PT . Differentiating the production function with respect to E and T, we
find that the marginal products of engineers and technicians are as follows:
20  2 E
MPE  Q / E  20  2E, and MPT  Q / T  12  T. Therefore, MPE / PE 
4,000
12  T
  MPT / PT . After applying some algebra, we find that T = E + 2.
2,000

Since Beiswanger allocates $28,000 per month for the total wages of engineers and
technicians, this implies that 28,000  PE E  PTT  $4,000E  $2,000( E  2). Solving this
equation for E, we find that E = 4; therefore, T = 6. Plugging E = 4 and T = 6 back into the
production function, we find that Q = 20(4) - 42 + 12(6) - 0.5(62) = 118. Thus the maximum
output possible for a monthly budget of $28,000 for the combined wages of engineers and
technicians is Q = 118 units. Note also that the y-intercept of the isocost line is equal to
M / PE  28,000 / 4,000  7 engineers, and the x-intercept of the isocost line is equal to
M / PT  28,000 / 2,000  14 technicians. If 7 engineers were hired, no technicians could be
hired and the firm would only be able to produce Q = 20(7) – 72 = 91. Similarly, if 14
technicians were hired, no engineers could be hired and the firm would only be able to
produce Q = 12(14) – 0.5(142) = 70.

1
 Table 4.1. Optimal input bundle decision for Beiswanger Company

Class Problem 4.2. (See “Problem Solved: The Efficient Minds of Managers”, p. 114 in
the textbook)

Managers need to search for input bundles to minimize costs for a given output.
Intuitively they need to balance the productivity of an input with its cost. Consider the
Miller Company, for which the relationship between output per hour (Q) and the number
of workers (L) and machines (K) used per hour is Q = 10(LK)0.5.

The wage of a worker is $80 per hour, and the price of a machine is $20 per hour. If the
Miller Company produces 800 units of output per hour, how many workers and machines
should managers use?

SOLUTION: The objective is to produce 800 units of output per hour at the lowest possible
cost. In order to determine the optimal number of workers and machines to employ, we
need to find the values for L and K at which the marginal products per dollar spent on
labor and machines are identical, i.e., we need to determine the values for L and K which

2
cause MPL / PL  MPK / PK . Differentiating the production function with respect to L and K,
we find that the marginal products of labor and capital are as follows:

MPL  5L.5 K.5  5(K / L).5 , and MPK  5L.5 K .5  5( L / K).5 .

Therefore,

5( K / L).5 5( L / K ).5
MPL / PL    MPK / PK .
80 20

By multiplying both sides of the previous equation through by ( K / L).5 , we obtain

5K 5
MPL / PL    5K  20 L; K  4 L.
80 L 20

Since Q = 800,

Q = 10(LK)0.5 = 800,
10(L(4L))0.5 = 800,
10(2L) = 800, and
L = 40 10(40K)0.5 = 800 40K = 802  K = 160.

Also note that the cost of producing 800 units using 40 units of labor and 160 units of
capital is 40($80) + 160($20) = $6,400.

Table 4.1. Optimal input bundle decision for Miller Company

3
Class Problem 4.3.1

Happiness can be produced with wine and roses according to Q  W .5 R.25 , where W is
bottles of wine and R is bouquets of roses obtained per month. If wine costs $20 per bottle
and roses cost $60 per dozen, find the happiness maximizing combination of wine and
roses costing $360.

SOLUTION: Q  W .5 R.25 , and the

budget condition is M =
PW W  PR R  20W  60R  $360. In
order to determine the optimal
number of bottles of wine and
bouquets of roses, we need to find
the values for W and R at which the
marginal products per dollar spent
on wine and roses are identical, i.e.,
we need to determine the values
for W and R which cause
MPW MPR
 . Since
PW PR
MPW  .5W .5 R.25 , MPR  .25W .5 R.75 , PW =$20, and PR =$60, we obtain
.5W .5 R.25 .25W .5 R.75 1
  2W 1R   2 R  W / 3. Substituting this back into the budget
20 60 3
30W
constraint, we obtain M  20W   $360  W  12 bottles. Substituting W = 12 back
3
into the budget constraint, we find that 20(12)  60R  $360  R  2 bouquets. Finally,
Q  W .5 R.25  12.5 2.25 = 4.9 units of happiness.

1This is a Chapter 4 problem that appeared on last fall's ECO 5315 Midterm Exam. Although it is presented
as a (decreasing returns to scale) optimal input problem, the "quantity" being maximized here (subject to the
$360 budget constraint) is essentially a psychological index indicating happiness. Later this semester, we
will formally reintroduce this index as a "utility" function, and use it to solve all sorts of interesting
problems, including topics like how investors trade off reward against risk, how firms structure managerial
compensation so as to align shareholder and manager incentives, etc. What's interesting here is that the
conceptual framework developed in chapter 4 generalizes to many other situations involving tradeoffs (in
this case, the tradeoffs pertain to consumer preferences regarding wine and roses, which are two highly
complementary goods!).