Question

Firm A’s production function and cost line are given by:

Q=Q(L,K)=2 L^(1/2) K^(1/2) (The production function)

?L+?=30000 (The cost line of firm A):

?L is the amount of labor hired.

?K is the amount of capital hired.

??p_L or the price of labor is 1 dollar per unit.

??p_K or the price of capital is 1 dollars per unit.

C or cost (think of it as the firm’s budget) is 30000 dollars.

How much labor and capital should this firm optimally hire?

Answer 1

Ans. Production function, Q = 2*L^(0.5) * K^(0.5)

Marginal product of labour, MPL = dQ/dL = (K/L)^0.5

Margial product of capital, MPK = dQ/dK = (L/K)^0.5

=> Marginal rate of technical substitution, MRTS = dK/dL = MPL/MPK = K/L

At optimal level,

MRTS = pL/pK

=> K/L = 1/1

=> K = L ---> Eq1

Substituting Eq1 in the cost line, L+ K = 30000, we get,

K + K = 30000

=> K = L = 15000 units

Thus, optimal level of labour hired 15000 units and capital hired is 15000 units.