Section B: Short Answers. Answer All Questions. (10 marks) 1. What is the elasticity of substitution? What does it tell us? 2. Could the solution to the firm's cost-minimization problem ever occur off the isoquant representing the required level of output? 3. How would an increase in the price of labor shift the long-run average cost curve? 4. Consider two perfectly competitive industries-Industry 1 and Industry 2. Each faces identical demand and cost conditions except that the minimum efficient scale output in Industry 1 is twice that of Industry 2. In a long-run perfectly competitive equilibrium, which industry will have more firms? 5. Why is the marginal revenue of a perfectly competitive firm equal to the market price?Section C: Calculations and Graphical Analysis Questions. Answer All Questions (30 marks) 1. A firm operates with the production function Q = K2L. Q is the number of units of output per day when the firm rents K units of capital and employs L workers each day. The marginal product of capital is 2KL, and the marginal product of labor is K2. The manager has been given a production target: Produce 8,000 units per day. She knows that the daily rental price of capital is $400 per unit. The wage rate paid to each worker is $200 day. (15 marks) A. Currently the firm employs at 80 workers per day. What is the firm's daily total cost if it rents just enough capital to produce at its target? (3 marks) B. Compare the marginal product per dollar sent on K and on L when the firm operates at the input choice in part (a). What does this suggest about the way the firm might change its choice of K and L if it wants to reduce the total cost in meeting its target (5 marks) C. In the long run, how much K and L should the firm choose if it wants to minimize the cost of producing 8,000 units of output day? What will the total daily cost of production be? (7 marks) 2. Ron's Window Washing Service is a small business that operates in the perfectly competitive residential window washing industry in Evanston, Illinois. The short-run total cost of production is STC(Q) = 40+ 100 + 0.10', where O is the number of windows washed per day. The corresponding short-run marginal cost function is SMC(Q) = 10 + 0.20. The prevailing market price is $20 per window. (15 marks) A. How many windows should Ron wash to maximize profit? (3 marks) B. What is Ron's maximum daily profit? (3 marks) C. Graph SMC, SAC, and the profit-maximizing quantity. On this graph, indicate the maximum daily profit. (3 marks) D. What is Ron's short-run supply curve, assuming that all of the $40 per day fixed costs are sunk? (3 marks) E. What is Ron's short-run supply curve, assuming that if he produces zero output, he can rent or sell his fixed assets and therefore avoid all his fixed costs? (3 marks) THE END Page 5 of 5
