Question

You are an efficiency expert hired by a manufacturing firm that uses K and L as inputs. The firm produces and sells a given output. If w = $40, r = $100, MPL = 20, and MPK = 40 the firm:
A. is cost minimizing.
B. should use less L and more K to cost minimize.
C. should use more L and less K to cost minimize.
D. is profit maximizing but not cost minimizing.

Answer 1

Answer: C. should use more L and less K to cost minimize.

Explanation:

The condition equilibrium means that the MPL/w = MPK/r.

What this implies is that the last dollar spent on capital brings in the equivalent change in the output as the last dollar spent on labour.

So inputting the values, we have,

This implies 4/40 = 40/100

This implies 0.10 < 0.40

So therefore return from capital is much, the firm needs to do more of hiring capital and less of hiring labour, so that the marginal product of labour could be able to increase and using more capital would imply fall in marginal product of capital and a state would be reached where the ratios of MPL/w and MPK/r be the same.

So therefore the correct option is C.