Question

The theory behind deregulating various product markets like air travel, trucking, and so on was to break down monopoly power, do away with regulation that was generally ineffective, and make the markets more competitive. Holding all else constant, when monopoly power is broken down, an industry should be able to produce more output at a lower price. Consider a firm with a production function given by the equation Q = L K. In the short run suppose the level of capital is fixed at 16 units. The marginal product of labor in the short run is given by the equation 2 . L MP L = Suppose initially that a firm has been granted monopoly power by the government and faces a demand curve given by P = 20 − 0.5Q. The firm faces competition in the labor market where the going price of labor is $10. Suppose that regulation is ineffective and the firm acts as a normal profit-maximizing monopolist. *29a. Find the equation for the firm’s labor demand curve. Find the optimal level of labor for the firm to demand.

Answer 1

29. (a) We have the production function as . In the short run, capital is fixed, and hence the production function would be , and we have . The cost is , and for rK be the fixed cost, we have , as the price of labor is $10. Hence, or is the cost function.

The marginal cost would be .

The total revenue would be or . The marginal revenue would be or or .

The profit maximizing level would be where the MC is equal to MR, ie or . The profit maximizing price would be hence or dollars.

The labor demand would be or units.