Chapter 6

Firms and Production

 Answers to Textbook Questions

1.1 Owners of firms without limited liability benefit from 100% of the company’s gains, but also
suffer 100% of the company’s losses, including possibly losing their personal assets. Owners of
firms with limited liability benefit from company gains, but company losses do not affect them
beyond the investment they made in the company stock. Thus, owners of limited liability
companies are more willing to take risks, like investing in large capital projects. Hence, limited
liability companies are more likely to grow.
1.3 Corporations have limited liability: The personal assets of the corporate owners cannot be taken to
pay a corporation’s debt if it goes into bankruptcy. Because of the limited liability of corporations,
the most that shareholders can lose if the firm goes bankrupt is the amount they paid for their
stock, which becomes worthless if the corporation fails.
2.1 The more time a firm has to adjust its inputs, the more factors of production it can alter. The short
run is a period so brief that at least one factor of production cannot be varied.
2.3 The production function shows only the maximum amount of output that can be produced from
given levels of labor and capital because the production function includes only efficient
production processes. A firm engages in efficient production if it cannot produce its current level
of output with fewer inputs, given existing knowledge about technology and the organization of
production. The combination q = 10, L = 3, and K = 6 cannot be a point on the production function
with point q = 10, L = 3, and K = 5 because it would not be efficient.
3.1 The total product curve is q = 6L, the average product of labor curve is q/L = 6, and the marginal
product of labor curve is ∆q/∆L = 6. The graph of the total product curve, with q on the vertical
axis and L on the horizontal axis, is a line with a slope of 6. The graphs of the average and
marginal product of labor curves, with average and marginal product on the vertical axis and L on
the horizontal axis, are horizontal lines at a height of 6 units.

3.3 Obtain the short-run production function by setting K equal to 50 . The short-run production
function is
q = 3L + 2K
q = 3L + 2(50)
q = 3L + 100.

© 2018 Pearson Education Ltd.

95 Perloff • Microeconomics, Eighth Edition, Global Edition

Determine the marginal product of labor by showing how q changes as L increases. The marginal
product of labor (MPL) is
MPL = Δq/ΔL = 3.
3.5 The law of diminishing marginal returns indicates that, if a firm keeps increasing one input while
holding all other inputs and technology constant, the corresponding increases in output will
become smaller eventually. For example, when the number of machines is fixed, with too many
workers sharing too few machines, each extra worker produces less extra output.
The law of diminishing returns generally holds because there is at least one fixed factor of
production in the short run, and thus, at some point, it must become scarce relative to the variable
input(s).
3.7 The law of diminishing marginal returns holds that if a firm increases the use of one factor of
production while holding all other inputs and technology constant, the marginal product of that

factor will fall eventually. In the short run, capital is constant at . Thus,

a. and the marginal product of labor, found by taking the difference between output at
L + ∆L and output at L, is:

Since the marginal product of labor is constant, it does not change as labor increases, and this
production function violates the law of diminishing marginal returns.

b. and the marginal product of labor, found by taking the difference between output at L
+ ∆L and output at L, is:

As the marginal (and average) product of labor is constant, it does not change as labor
increases, and this production function violates the law of diminishing marginal returns.

c. and, using calculus, the marginal product of labor is:

falls as labor rises, and so too does the MPL, in keeping with the law of
diminishing marginal returns.

© 2018 Pearson Education Ltd.

 Chapter 6 Firms and Production 96

4.1 We can say that the firm is not producing efficiently. It should be able to produce more output
with the same amount of capital and more labor. If it is not, then the firm is not on the highest
isoquant it could be on, and it is wasting the extra labor.
4.3 If an isoquant were thick, it would imply that the addition of both capital and labor from a point on
the inside edge of an isoquant to the outer edge of the same isoquant would not increase output.

4.5 The isoquant for workers who are perfect substitutes, as in part (a), is drawn as a downward-
sloping straight line because a producer is indifferent in every case to which worker they hire. For
parts (b) and (c), the isoquant would be drawn as a typical downward-sloping convex curve.

4.7 Using Equation 6.3, we know that the marginal rate of technical substitution is

4.9 The isoquant looks like right angles because the firm cannot substitute between disks and
machines but must use them in equal proportions: one disk and one hour of machine services.
4.11 Assume a fourth fixed-production technology exists such that 200 ten-layer chips per day can be
produced with 2 units of labor and 6 units of capital, but additional labor will not produce more
output without additional capital, and additional capital will not produce more output without
additional labor.
Because 200 ten-layer chips per day can be produced with 2 units of labor and 6 units of capital,
but additional labor will not produce more output without additional capital and additional capital
will not produce more output without additional labor, the isoquant for the new, fourth technology
will be L-shaped, passing through the bundle L = 2 and K = 6. The isoquant for all technologies
combined will outline the combinations of inputs from the various technologies that produce 200
units of output using the smallest quantity of inputs. As additional technologies are added, the
isoquant for all technologies becomes smoother. A fifth technology is shown that is inefficient,
indicating it will not be used, because it lies further from the graph’s origin than the isoquant for
the combined technologies.

© 2018 Pearson Education Ltd.

97 Perloff • Microeconomics, Eighth Edition, Global Edition

These functions have different marginal products but the same MRTS.
4.13 Isoquants will be downward-sloping straight lines. With natural gas on the horizontal axis, the
MRTS will be -5.45.
5.1 The inputs are medical supplies (capital) and medical personnel (labor). The output is medical aid.
The production process likely allowed for imperfect substitution between the inputs so that the
isoquants are downward sloping and convex to the origin, indicating the ability to substitute one
input for another.
5.3 An isoquant is a curve that shows the efficient combinations of labor and capital that can produce
the same level of output.
In the following figure, assume the firm currently produces at point a, using 1 worker and 1 unit of
capital on isoquant q = 1.
Constant returns to scale is a property of a production function whereby when all inputs are
increased by a certain percentage output increases by that same percentage. To exhibit constant
returns to scale, isoquant q = 2 must contain the input combination with 2 workers and 2 units of
capital.
Diminishing marginal returns are present when, if a firm keeps increasing an input, holding all
other inputs and technology constant, the corresponding increases in output become smaller
(diminish). To exhibit diminishing returns to labor, labor must increase by more than 1 unit,
holding capital constant, to increase production from 1 to 2. Similarly, to exhibit diminishing
returns to capital, capital must increase by more than 1 unit, holding labor constant, to increase
production from 1 to 2.

© 2018 Pearson Education Ltd.

 Chapter 6 Firms and Production 98

5.5 Returns to scale is a property of production functions that relates the percentage change in
production to the same percentage change in all inputs. For example, if both K and L are doubled
(both are increased by 100%), then for the Cobb-Douglas production function, q = KaLb, output
rises to

A production function exhibits constant returns to scale when a doubling of both K and L causes
output to double (increase by 100%). For the Cobb-Douglas production function, this means that a
+ b = 1, so the percentage increase in output is

.
A production function exhibits increasing returns to scale when a doubling of both K and L causes
output to more than double (increase by more than 100%). For a Cobb-Douglas production
function, this means that a + b > 1. To illustrate this, if a + b = 1.5, then the percentage increase in
output would be

© 2018 Pearson Education Ltd.

99 Perloff • Microeconomics, Eighth Edition, Global Edition

5.7 The Danish food and beverages firm exhibits decreasing returns to scale, as a + b = 0.69 + 0.18 =
0.87 < 1.

The Japanese rubber firm exhibits constant returns to scale, as a + b = 0.5 + 0.5 = 1.

The New Zealand mining firm exhibits increasing returns to scale, as a + b = 0.69 + 0.45 = 1.14 >
1.

However, each of the three firms exhibits diminishing marginal returns as, for each,

and the average product of labor falls for each as labor increases, and the average product of
capital falls as capital increases.

Thus, a production function can exhibit diminishing marginal returns regardless of whether it
exhibits increasing, decreasing, or constant returns to scale.

However, if a = 1 and b = 1, then the production function exhibits increasing returns to scale since
a + b = 1 + 1 = 2 > 1, but both marginal products are constant, so they do not vary as their
respective inputs vary, which violates the law of diminishing marginal returns.

6.1 We do not have enough information to determine which company is more productive, as Firm 1
may use more capital input than Firm 2. If that is the case, it is possible that with the same
capital/labor mix as Firm 2, Firm 1 would produce less than Firm 2.
6.3 Neutral technical progress leaves the shape of isoquants unchanged, but each isoquant is
associated with more output. This type of technical progress is labor-saving. As shown in the
figure below, technical progress in farming has enabled less labor to produce the same output
using the same amount of capital.

6.5 Robots are labor-saving inputs because they are substitutes for workers in this case.

© 2018 Pearson Education Ltd.

 Chapter 6 Firms and Production 100

7.1 If the firm has a Cobb-Douglas production function, Q = ALαK β, with alpha < 1, the marginal
product of labor is decreasing in labor; therefore, as the amount of labor decreases from layoffs,
the marginal product of labor increases. If the production function is one of perfect substitutes, the
marginal product of labor will not change with layoffs.

© 2018 Pearson Education Ltd.