Question

Sienna runs a teddy bear factory that produces bears q using labour L and capital K. At first, her manager is Edward and the factory produces bears according to the production function q = f(L, K). Then, she hires a new manager, Theodore, who is much better than Edward and he is able to get the factory to produce 30% more bears for every pair of inputs L and K than Edward could.

(1) Write down the new production function once Theodore is manager.

(2) Is this a neutral technical change?

(3) Do the MPL and MPK change? If/so, by how much? Explain.

(4) Does the MRT S change? If/so, by how much? Explain.

(5) Do the returns to scale change? If/so, how? Explain.

Answer 1

1. Still, the production function remains the same as q= f(L,K)

Because, labor and capital are still the same.

2. This is neutral technical change as technology remains same.

3.MPL= Marginal product of labor. It is given by a formula: Change in production/ change in labor

In this case, as production is increasing MPL increases. So is MPK which marginal product of capital.

4. MRTS is marginal rate of technical substitution. It shows rate at which can substitute one input (eg. labor) for another input, (eg. capital) without changing the level of resulting output. In this case as labor and capital are the same, MRTS is same.

5. Returns to scale shows increasing returns to scale as input is same but output now is more.