Specialty Steel has carefully measured production in its new plant to determine

Question

Specialty Steel has carefully measured production in its new plant to determine whether it is technically efficient in production. It has found that, for its two inputs K and L, it has the following marginal products: MPK = 15 units and MPL = 22 units. The inputs are hired in perfectly competitive markets, and the firm faces input costs of PK = $7.50 and PL = $10 per unit. You have been hired as a consultant to assist Specialty in increasing profitability. What do you recommend about production planning? Explain.

Explanation / Answer

The marginal product of a factor is the change in output resulting in increasing the factor by a unit. increasing a unit of technology results in creation of 15 units of output. Now the inout cost for one unit of technology is $7 50. Hence 15 units of output is produced with a $7.50 investment in an additional unit of technology. In other words every dollar investment in technology produces two additional unit in output

Similarly ever additional labour resource produces 22 units as output. A labour resource costs $10 and by that yard stick every additonal dollar of investment will produces 2.2 additonal unit of output.

Hence it appears that the company is more labour efficient and should initially invest in labour for increased profitability.

However, one has to bear in mind the law of diminishing marginal productivity I.e. with increasing production the marginal productivity of labour will decrease from its present 22 to less than 20. In such a case the return on every dollar invested in technology shall outstrip that of labour and at that point one must invest more in technology

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