Problem set 5: industrial organization, factor markets
J. Wahl – Microeconomic Principles – Winter 2009
1. Please indicate what type of returns to scale the following production functions
have:
Q=100K1/2L1/3
Q=2L + 5K
2. A monopoly firm has two plants that operate with different cost functions:
MC1= 20 + 2Q1MC2 = 10 + 5Q2
Estimated demand for the company’s product is P = 40-3/2 Q. (Note that Q=Q1+Q2)
How much should the firm plan to produce in each plant, and at what price should it sell
its product?
3. Suppose that a steel plant’s production function is q=10LK, where q is output, L
is amount of labor, and K is amount of capital. Suppose the price of labor is $2 per unit
and the price of capital is $5 per unit. The firm’s VP of manufacturing hires you to figure
out what combination of inputs the plant should use to produce 20 units of output. What
advice do you give and why?
4. The Acme Chemical Company operates in a perfectly competitive industry.
a. On a well-labeled graph, please sketch the AFC, AVC, AC, and MC
curves for the firm in the short-run. Highlight the supply curve.
b. Now suppose that the town in which Acme is located passes a law that
requires all firms to contribute $5000 to a pollution clean-up effort. What curves will be
affected by the new law? Will the firm shut down?
c. Now suppose instead that the town charges $1000 if the firm is not
operating and $7000 if the firm is operating. How would Acme decide whether to produce
or not?
5. Before the reserve clause was abolished in a collective bargaining agreement in
1976, major league baseball players were generally not free to negotiate with any team
other than the one they were already playing for. Teams could negotiate with other teams
for players, but individual players already playing for, say, the Twins couldn't directly
bargain with, say, the Brewers in order to get a higher salary.
a. After the reserve clause was abolished, players were free to negotiate with teams
other than the one for which they were currently playing. Players' salaries went up on
average by more than 38% in REAL terms in 1977, and by nearly 22% in REAL terms in
1978. For example, former Twin Larry Hisle went over to the Brewers, and his salary
went from $47,500 a year to $525,833 a year. Can you give an economic explanation
for this?
b. After the reserve clause was abolished, the average player contract expanded from
one year to three or more years in length. Consequently, players did not have to negotiate
a new contract every season. At the same time, reported injuries rose substantially.
Larry Hisle, for example, had a shoulder injury that put him out of baseball shortly after
he signed a multi-year contract with the Brewers. Can you give an economic explanation
for what happened?
