Suppose a firm finds that the marginal product of capital is 60 and the marginal

Question

Suppose a firm finds that the marginal product of capital is 60 and the marginal product of labor is 20. If the price of capital is $6 and the price of labor is $2.50, describe how the firm should adjust its mix of capital and labor? What will be the result? Suppose a firm finds that the marginal product of capital is 60 and the marginal product of labor is 20. If the price of capital is $6 and the price of labor is $2.50, describe how the firm should adjust its mix of capital and labor? What will be the result? Suppose a firm finds that the marginal product of capital is 60 and the marginal product of labor is 20. If the price of capital is $6 and the price of labor is $2.50, describe how the firm should adjust its mix of capital and labor? What will be the result?

Explanation / Answer

MPL/PL = 20/2.5= 8
MPK/PK = 60/6 = 10

Since, per unit marginal product of capital is higher than labor. Hence for greater productivity labor has to be moved to capital.

For Max output MP(K)/MP(L) = P(K)/P(L).

                   60/20 = 6/2.5

                  3 = 2.4

Therefore, labor should moved to capital then MP(L) will increase and MP(K) will decrease. This will finally bring down the L.H.S to R.H.S. The productivity will boost as the firm will be on a higher isoquant than before.

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