1. Suppose the cost of labor r

1. Suppose the cost of labor rises by 25% and are expected tostay at that level for a long time. Show graphically how thischange in the relative price of labor and capital affects thefirm’s expansion path. (7 pts)

2. Suppose that a firm’s production function is q =2L1/2K1/2. The cost of aunit of labor is $18.50 and the cost of a unit of capital is $20.The firm is currently producing 1,000 units of output and hasdetermined that the cost minimizing quantities of labor and capitalare 100 and 20, respectively. Write the function form of isoquant(K as a function of L, given q = 1,000).Also write the function form of isocost. (8 pts)

3. Give an example of an implicit opportunity cost,based on observation in your daily life, as a student, a worker, oran entrepreneur. Implicit cost is cost that does not require anoutlay of money. (6 pts)


(1) Due to increase in cost oflabour the slope of isocost curve will increase and they will pivotinside from orange isocost lines to blue isocost lines. The new tangencyconditions for cost minimization is shown at point A’ and B’joining which we get our new expansion path shown byblack straightline passing through origin. We see that compared to originalexpansion path (Red straightline passing through origin) relatively more capital is used thanlabour along the new expansion path. This happens due to relativeincrease in the price of labour.   

(2) Isoquant given q=1000:


We have, cost of a unit of labour (w) = $18.50, cost of a unitof capital (r) = $20

cost minimizing quantity of labour (L) =100 and cost minimizingquantity of capital (K) =20  

  Total cost of producing (q=1000) = wL+rK = $18.50(100) + $20 (20) = $2250.

Isocost when cost = $2250:



Profession Implicit Cost
Student Wage lost not working at the market wagewith the present qualifications
Worker Profits he/she can earn doing his/her ownbusiness
Entrepreneur Wage that he/she could earn as an employworking in other firm

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