Exercise 3: Production and Cost Theories

1. Consider estimation of a short-run average variable cost function of the form: AVC =
a+bQ+cQ2. Using the data presented below, the estimation producers produces the
following computer output:

Q Q2 AVC
300 90000 36.26
100 10000 37.33
150 22500 27.1
250 62500 26.89
400 160000 45.1
200 40000 31.34
350 122500 42.24
450 202500 55.13
500 250000 61.73

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SUMMARY
OUTPUT

Regression Statistics
Multiple R 0.96859662
R Square 0.938179412
Adjusted R Square 0.917572549
Standard Error 3.46527547
Observations 9

ANOVA
Significanc
df SS MS F eF
546.700 45.5275
Regression 2 1093.401195 6 2 0.000236
12.0081
Residual 6 72.0488045 3
Total 8 1165.45

Standard Upper
Coefficients Error t Stat P-value Lower 95% 95%
6.85542 0.00047 60.3474
Intercept 44.473523 6.487345442 7 4 28.59956 9
0.02535
Q -0.1426427 0.048225836 -2.95781 5 -0.26065 -0.02464
4.58963 0.00373 0.00055
Q2 0.0003624 7.8981E-05 2 2 0.000169 6

AVC = a+ bQ + cQ^2 = 44.47- 0.143Q + 0.00036Q^2

dAVC/dQ = -0.143 +0.00072Q = 0; Q = 0.143/0.00072 = 199

AVC ( min at Q = 199) = 44.47- 0.143Q + 0.00036Q^2

Required:

(i) Do the parameter estimates have the correct signs? Are they statistically significant at
the 5 percent level of significance?
(ii) At what level of output do you estimate AVC reaches its minimum value?
(iii) What is the estimated marginal cost curve?
(iv) What is the estimated marginal cost when the output reached at its minimum ( from i)

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2. Given the following data on output and inputs for 10 production periods:
CAPITA LNLABO
TIME OUTPUT L LABOR LNOUT LNK R
1 225 10 20 5.4161 2.302585 2.995732
2 240 12 22 5.480639 2.484907 3.091042
3 278 10 26 5.627621 2.302585 3.258097
4 212 14 18 5.356586 2.639057 2.890372
5 199 12 16 5.293305 2.484907 2.772589
6 297 16 24 5.693732 2.772589 3.178054
7 242 16 20 5.488938 2.772589 2.995732
8 155 10 14 5.043425 2.302585 2.639057
9 215 8 20 5.370638 2.079442 2.995732
10 160 8 14 5.075174 2.079442 2.639057
(i) Estimate the parameters (A, α , β ) of Cobb-Douglas production function using
α β
the Least-squares (OLS) regression method. [ Assume Q= AK L ]
(ii) Use the estimated parameters to determine: Returns to Scale, Equations for the
marginal product of labor and Capital.
(iii) Calculate the marginal products of capital and labor for the input combinations :
K = 20, L = 30.
3. A micro-entrepreneur produces caps and hats for women. The output-cost data of the business is
reproduced below:

Output Total Cost

50 870

100 920

150 990

200 1240

250 1440

300 1940

350 2330
a. Estimate the total cost function and then use that equation to determine the average and marginal
cost functions. Assume a cost function.
b. Determine the output rate that will minimize average cost and the per-unit cost at that rate of
output.
c. The current market price of caps and hats per unit is Tk. 6.00 and is expected to remain at that
level for the foreseeable future. Should the firm continue its production?

4. Using the following costs functions find the output level at which Average Variable Cost (AVC)
is minimum::

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 TC=1, 000+10 Q−0 .9 Q2 +0 .04 Q 3 . Hint: Find MC from TC, Find Total Variable Cost
by subtracting the fixed cost component (Taka 10,000) to get TVC =
2 3
TC=0Q−0 . 9Q +0. 04 Q , Find AVC = TVC/Q; Solve for MC = AVC. Alternatively
you can take the first derivative (F.O.C) of AVC function and solve for the Minimum Q.

5. The engineering department of ABC Co. Limited has developed the following output-cost data
for a proposed new plant to produce ammonium sulfate fertilizer:

OUTPUT CAPITAL
50 870
100 920
150 990
200 1240
250 1440
300 1940
350 2330
400 3100
(i) Estimate the total cost function and then use that equation to determine the average and
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marginal cost functions. Assume a quadratic TC function = TC=C0 +C1 Q+C 2 Q
(ii) Determine the output rate that will minimize average cost and the per-unit cost at
that rate of output.
(iii) The current market price of this fertilizer is Taka 5.50 per unit and is expected to
remain at that level for the foreseeable future. Should the plant be built?
6. Using the following equations, find the profit maximizing output and maximum profit.

Q=90−2 P , P=45−0.5Q; TC=Q3 −8 Q2 +57 Q+2 ; π = profit=TR−TC

Computing Profit-Maximizing Price and Output (For a Monopolist).

TC=500+20 Q2 ; P = 400-20Q; TR= p .Q=400 Q−20Q 2 . Hint: Solve for MR = MC;

Take the derivative of TC to get MC and take the derivative of TR to get MR.