Microeconomic Theory Basic Principles and Extensions 11th Edition Nicholson Solutions Manual

Microeconomic Theory Basic Principles
And Extensions 11th Edition Nicholson

Solutions Manual
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CHAPTER 10:
Cost Functions
The problems in this chapter focus mainly on the relationship between production and
cost functions. Most of the examples developed are based on the Cobb-Douglas function
(or its CES generalization), although a few of the easier ones employ a fixed proportions
assumption. Two of the problems (10.7 and 10.8) make use of Shephard's Lemma since
it is in describing the relationship between cost functions and (contingent) input demand
that this envelope-type result is most often encountered. The analytical problems in this
chapter focus on various elasticity concepts, including the introduction of the Allen
elasticity measures.
Comments on Problems
10.1 An introduction to the concept of “economies of scope”. This problem illustrates
the connection between that concept and the notion of increasing returns to scale.
10.2 A simplified numerical Cobb-Douglas example in which one of the inputs is held
fixed.
10.3 A fixed proportion example. The very easy algebra in this problem may help to
solidify basic concepts.
10.4 This problem derives cost concepts for the Cobb-Douglas production function
with one fixed input. Most of the calculations are very simple. Later parts of the
problem illustrate the envelope notion with cost curves.
10.5 Another example based on the Cobb-Douglas with fixed capital. Shows that in
order to minimize costs, marginal costs must be equal at each production facility.
Might discuss how this principle is applied in practice by, say, electric companies
with multiple generating facilities.
10.6 This problem focuses on the Cobb-Douglas cost function and shows, in a simple
way, how underlying production functions can be recovered from cost functions.
10.7 This problem shows how contingent input demand functions can be calculated in
the CES case. It also shows how the production function can be recovered in such
cases.
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a
publicly accessible website, in whole or in part.
Chapter 10: Cost Functions 101
10.8 Famous example of Viner's draftsman. This may be used for historical interest or
as a way of stressing the tangencies inherent in envelope relationships.
Analytical Problems
10.9 Generalizing the CES cost function. Shows that the simple CES functions used
in the chapter can easily be generalized using distributional weights.
10.10 Input demand elasticities. Develops some simple input demand elasticity
concepts in connection with the firm’s contingent input demand functions (this is
demand with no output effects).
10.11 The elasticity of substitution and input demand elasticities. Ties together the
concepts of input demand elasticities and the (Morishima) partial elasticity of
substitution concept developed in the chapter. A principle result is that the
definition is not symmetric.
10.12 The Allen elasticity of substitution. Introduces the Allen method of measuring
substitution among inputs (sometimes these are called Allen/Uzawa elasticities).
Shows that these do have some interesting properties for measurement, if not for
theory.
Solutions
10.1 a. By definition, total costs are lower when both q1 and q2 are produced by
the same firm than when the same output levels are produced by different
firms. C ( q1 , 0 ) simply means that a firm produces only q1.
b. Let q = q1 + q2 , where q1 , q2  0. By assumption,

C (q1 , q2 ) C (q1 , 0)
 ,
q q1
implying
q1C (q1 , q2 )
 C ( q1 , 0).
q
Similarly,
q2C (q1 , q2 )
 C (0, q2 ).
q
Summing yields
C(q1 , q2 )  C (q1 ,0) + C (0, q2 ).
This proves economies of scope.
102 Chapter 10: Cost Functions
10.2 a. Substituting into the production function,

q = 9000.5 J 0.5 = 30 J .
Setting q = 150 and solving yields J = 25. Similarly, J = 100 when
q = 300, and J = 225 when q = 450.
b. Because Smith’s effort is sunk, to compute marginal cost we only need to

consider Jones’ effort in the cost function. To produce q pages requires
q2
J=
900
hours of work. At $12 per hour, this leads to the cost function
12q 2
C= .
900
Thus
C 24q 2q
MC = = = .
q 900 75
We have
q = 150  MC = 4
q = 300  MC = 8
q = 450  MC = 12.
10.3 Given q = min ( 5k ,10l ) .
a. In the long run, no input should be wasted. Hence 5k = 10l = q, implying

k = 2l = q 5. Thus
C = vk + wl
= v (2l ) + wl
q  q
= v   + w 
5  10 
q
= ( 2v + w ) .
10
Therefore,
C 2v + w
AC = =
q 10
C 2v + w
MC = = .
q 10
b. q = min ( 50,10l ) when k = 10. There are two cases to consider. First, if
l  5, then q = 10l , implying q  50. Hence
q
STC = 10v +   w,
 10 
implying
STC 10v w
SAC = = +
q q 10
STC w
SMC = = .
q 10
If l  5, then q = 50. It is impossible to produce more than 50 in
the short run. Hence STC = SAC = SMC =  for q  50.
Finally, right at q = 50, we have the same formula for total cost as
above:
q
STC = 10v +   w.
 10 
SMC is technically not defined because the STC has different derivatives
to the right and left of q = 50. However, SAC is well-defined, and is the
same as the previous formula:
STC 10v w
SAC = = + .
q q 10
c. Substituting v = 1 and w = 3 into the forumlae from the previous parts, in

the long run, AC = MC = 1 2. In the short run, for q  50,
STC 10 3
SAC = = +
q q 10
STC 3
SMC = = .
q 10
10.4 Given q = 2 kl , k = 100.
a. Since q = 2 100 l , q = 20 l . Rearranging,

q
l= ,
20
implying
2
q
l= .
400
Hence,
 q2  q
2
SC = vk + wl = 1(100) + 4  = 100 + .
 400  100
STC 100 q
SAC = = + .
q q 100
b. We have
SC q
SMC = = .
q 50
If q = 25,
 25 2 
SC = 100 +   = 106.25
 100 
100 25
SAC = + = 4.25
25 100
25 1
SMC = = .
50 2
If q = 50,
 50 2 
SC = 100 +   = 125
 100 
100 50
SAC = + = 2.5
50 100
50
SMC = = 1.
50
If q = 100,
 100 2 
SC = 100 +   = 200
 100 
100 100
SAC = + =2
100 100
100
SMC = = 2.
50
If q = 200,
 200 2 
SC = 100 +   = 500
 100 
100 200
SAC = + = 2.5
200 100
200
SMC = = 4.
50
c.
d. As long as the marginal cost of producing one more unit is below the
average-cost curve, average costs will be falling. Similarly, if the
marginal cost of producing one more unit is higher than the average cost,
then average costs will be rising. Therefore, the SMC curve must intersect
the SAC curve at its lowest point.
e. Since q = 2 kl , q 2 = 4kl , implying

2
q
l= .
4k
Substituting,
wq 2
SC = vk + wl = vk + .
4k
f. Deriving the first-order condition from the previous expression,

SC wq 2
=v− = 0.
k 4k 2
Rearranging,
q w
k= .
2 v
g. Substituting first for l and then for k into the cost function,
C = vk + wl (k )
q2
= vk + w
4k
 q w  wq 2  2 v 
= v   +  
 2 v  4  q w 
= q vw ,
(a special case of Example 10.2).
h. If w = 4 and v = 1, in the long run, C = 2q.

Let’s examine the short run in different cases. Fixing k = 100 in
the short run,
2
q
SC (k = 100) = 100 + .
100
This is tangent to the long-run cost function for q = 100, as one can verify
SC = 200 = C.
Fixing k = 200 in the short run
2
q
SC (k = 200) = 200 + .
200
SC = 400 = C.
Finally, fixing k = 400 in the short run,
2
q
SC (k = 400) = 400 + .
400
SC = 800 = C.
10.5 a. Total output is q = q1 + q2 , with

q1 = 25l 1 = 5 l 1
q 2 = 10 l 2 .
Thus
2
q
SC1 = 25 +l1 = 25 + 1
25
2
q
SC2 = 100 + 2 ,
100
implying total short-run cost is
2 2
q1 q
SC = SC1 + SC2 = 125 + + 2 .
25 100
To minimize cost, set up Lagrangian:
L = SC +  (q − q1 − q2 ).
Taking the first-order conditions,
2q
Lq1 = 1 −  = 0
25
2q
Lq2 = 2 −  = 0.
100
Therefore 4q1 = q2 .
b. Since 4q1 = q2 , we have q1 = q 5 and q2 = 4q 5. Therefore,
2
q
SC = 125 +
125
2q
SMC =
125
125 q
SAC = + .
q 125
Substituting various quantities, SMC (100) = $1.60, SMC (125 ) = $2.00,
and SMC ( 200 ) = $3.20.
c. In the long run, given constant returns to scale, location doesn't really
matter because one can change k . The entrepreneur could split evenly or
produce all output in one location, etc.
C = k + l = 2q.
AC = 2 = MC .
d. If there are decreasing returns to scale with identical production functions,

then the entrepreneur should let each firm have equal share of production.
AC and MC not constant anymore, becoming increasing functions of q.
10.6 a. From Shephard's Lemma,

1
C 2  v  3
l= = q 
w 3  w 
2
C 1  w  3
k= = q  .
v 3  v 
b. Eliminate the w v from these equations:

q = (3 2)
23
31 3 l 2 3 k 1 3 = Bl 2 3k 1 3 .
This is a Cobb-Douglas production function.
10.7 a. As for many proofs involving duality, this one can be algebraically messy
unless one sees the trick. Here the trick is to let
B = ( v.5 + w.5 ) .
With this notation, C = B2 q. Using Shephard’s lemma,
C
k= = Bv −0.5 q.
v
C
l= = Bw−0.5 q.
w
b. From part a,
q v 0.5
= .
k B
q w0.5
= .
l B
Thus,
q q
+ = 1.
k l
k −1 + l −1 = q −1.
The production function then is q = (k −1 + l −1 )−1 .
c. This is a CES production function with r = −1. Hence,

1
s= = 0.5.
1- r
Comparison to Example 8.2 shows the relationship between the
parameters of the CES production function and its related cost function.
10.8 Support the draftsman. It is geometrically obvious that SAC cannot be at

minimum because it is tangent to AC at a point with a negative slope. The only
tangency occurs at minimum AC.
Analytical Problems
10.9 Generalizing the CES cost function
1
1−
1
 v  1−
 w  1−
a. C = q    +   .
     
b. C = q −  −  v w .
wl 
c. = .
vk 
d. Using Shephard’s Lemma with the cost function derived in part a,
1
1− 1− −1
C
1
  1   v 
 1−
w 
l= =q     +    w−   −1
w  1 −         
1
1− 1− −1
C
1
 1−
w 
  1   v 
k= =q     +    v −   −1
v  1 −  
   
  
Thus, labor’s relative share is
1 1
 1  −1
( v  ) + ( w  )  1− w1−   −1
 1− 1−
q  
1−   
= 1
wl
1
vk  1  1− 1− −1 1−  −1
 ( ) ( )  v 
1−
q  v  + w  
1−  
1−
w  
=   .
v 
Labor’s relative share depends on  . If   1, labor’s
share moves in the opposite direction as w v and the same direction as
  . If   1, the opposite is true. This accords with intuition on how
substitutability should affect shares.
10.10 Input demand elasticities
a. The elasticities can be read directly from the contingent demand functions
in Example 10.2. For the fixed proportions case,
el c ,w = ek c ,v = 0
This is because q is held constant. For the Cobb-Douglas,

el c , w = − +  .

−
ek c ,v = + .

Evidently, the CES in this form has non-constant elasticities.
b. Because cost functions are homogeneous of degree one in input prices,

contingent demand functions are homogeneous of degree zero in those
prices as intuition suggests. Using Euler’s theorem gives lwc w + lvc v = 0.
Dividing by l c gives the result.
c. Use Young’s Theorem:

l c  2C  2C k c
= = = .
v vw wv w
Now multiply the left-side by
vwl c
l cC
and the right by
vwk c
.
k cC
d. Multiplying by shares in part b yields

sl el c , w + sl el c ,v = 0.
Substituting from Part C yields
sl el c ,w + sk ek c ,w = 0 .
e. All of these results give important checks to be used in empirical work.
10.11 The elasticity of substitution and input demand elasticities
a. If wi does not change,

 ln( xic x cj )  ln( xic x cj )
si , j = =
 ln( w j wi )  ln( w j )
 ln x c
exc , w = i
i j
 ln w j
 ln x cj
exc , w =
j j
 ln w j
 ln xic  ln x j  ln( xi x j )
c c c
exc , w − exc , w = − = = si , j .
i j j j
 ln w j  ln w j  ln w j
b. If w j does not change,
 ln( x cj xic )  ln( x cj xic )
s j ,i = =
 ln( wi w j )  ln( wi )
exc , w =  ln x cj  ln wi
j i
exc , w =  ln xic  ln wi
i i
 ln x cj
 ln xic  ln( x j xi )
c c
ex c , w − ex c , w = − = = s j ,i .
j i i i
 ln wi  ln wi  ln wi
c. The cost function will be (similarly to Equation 10.26)


n  −1
C ( w1 , w2 ,..., wn , q) = q( wk  (  −1)
) .
k =1
n
Let B =  wk (  −1) .
k =1
By Shephard’s lemma,
C ( w1 , w2 ,..., wn , q )
xic ( w1 , w2 ,..., wn , q) = = qB −1  wi1 (  −1)
wi
C ( w1 , w2 ,..., wn , q )
x cj ( w1 , w2 ,..., wn , q) = = qB −1  w1j (  −1)
w j
xic w j −1 −1  (  −1)
ex c , w =  c = B wj
i j
w j xi  −1
x cj w j 1  1 
ex c , w =  c = − B −1w j (  −1)
 = − + exic , w j
j j
w j x j  − 1   − 1 
x cj wi −1 −1  (  −1)
ex c , w =  c = B wj
j i
wi x j  − 1
xic wi 1  1 
ex c , w =  c = − B −1wi (  −1)
 = − + excj , wi
i i
wi xi  − 1   − 1 
si , j = s j ,i = exc , w − exc , w = exc , w − exc , w =  .
i j j j j i i i
10.12 The Allen elasticity of substitution
a. By Shephard’s lemma:
C
xic = = Ci .
wi
Thus,
xic w j C wj wj
ex c , w =  c =  c = Cij 
i j
w j xi wi w j xi Ci
w j x cj w jC j
sj = =
C C
ex c , w wj C Cij C
i j
= Cij   = = Ai , j .
sj Ci w j C j Ci C j
b. We have
si p j
esi , p j = 
p j si
 ( pi Ci C ) pj
= 
p j pi Ci C
 ( Ci C ) p j C
= pi  
p j pi Ci
C ji C − Ci C j p j C
= pi  
C2 pi Ci
pj
= (C ji C − Ci C j )
Ci C
C ji C p jC j
= 
C j Ci − 1 C
= s j ( Ai , j − 1).
c. In the Cobb-Douglas case,

1  
 +  +  +
C=q Bv w ,
where
− −
B = ( +  )  +    +  .
Then,
 −
C     +  +
1
Cl = = q + B  v w
w  +  
− 
C     +  +
1
Ck = = q + B  v w
v  +  
− −
Ck     +   + 
1
Ckl = = q + B  2 
v w
w  ( +  ) 
Ckl C
Akl = = 1.
Ck Cl
In the CES case,

1 1
 1− 1− 1−
C = q (v +w ) .
Then

C
1
Cl = = q  (v1− + w1− )1− w−

w

C
1
Ck = = q  (v1− + w1− )1− v −

v
2 −1
C
1
Ckl = k = q   (v1− + w1− ) 1− v − w−

w
C C
Akl = kl =  .
Ck Cl

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Microeconomic Theory Basic Principles

And Extensions 11th Edition Nicholson

b. Let q = q1 + q2 , where q1 , q2  0. By assumption,

10.2 a. Substituting into the production function,

b. Because Smith’s effort is sunk, to compute marginal cost we only need to

10.3 Given q = min ( 5k ,10l ) .

a. In the long run, no input should be wasted. Hence 5k = 10l = q, implying

c. Substituting v = 1 and w = 3 into the forumlae from the previous parts, in

10.4 Given q = 2 kl , k = 100.

a. Since q = 2 100 l , q = 20 l . Rearranging,

e. Since q = 2 kl , q 2 = 4kl , implying

f. Deriving the first-order condition from the previous expression,

h. If w = 4 and v = 1, in the long run, C = 2q.

10.5 a. Total output is q = q1 + q2 , with

b. Since 4q1 = q2 , we have q1 = q 5 and q2 = 4q 5. Therefore,

d. If there are decreasing returns to scale with identical production functions,

10.6 a. From Shephard's Lemma,

b. Eliminate the w v from these equations:

c. This is a CES production function with r = −1. Hence,

10.8 Support the draftsman. It is geometrically obvious that SAC cannot be at

10.9 Generalizing the CES cost function

d. Using Shephard’s Lemma with the cost function derived in part a,

10.10 Input demand elasticities

b. Because cost functions are homogeneous of degree one in input prices,

c. Use Young’s Theorem:

d. Multiplying by shares in part b yields

e. All of these results give important checks to be used in empirical work.

10.11 The elasticity of substitution and input demand elasticities

a. If wi does not change,

c. The cost function will be (similarly to Equation 10.26)

10.12 The Allen elasticity of substitution

c. In the Cobb-Douglas case,

In the CES case,

Cl = = q  (v1− + w1− )1− w−

Ck = = q  (v1− + w1− )1− v −

Ckl = k = q   (v1− + w1− ) 1− v − w−

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