Question

A manager hires labor and rents capital equipment in a very competitive market. Currently the wage rate is $12 per hour and capital is rented at $8 per hour. The marginal product of labor is 60 units of output per hour and the marginal product of capital is 48 units of output per hour. The marginal product of both inputs is decreasing. In order to efficiently use these inputs, the firm should:

Answer 1

The firm should hire labor and rent capital until the value of the marginal product for each equals its market price.

Step-by-step explanation:

For a firm to efficiently use its inputs in a competitive market, it should aim to equalize the value of the marginal product of both labor and capital. The marginal product of labor (MPL) is 60 units per hour and the wage rate is $12 per hour. Hence, the value of the marginal product of labor is 60 units × output price. Similarly, the marginal product of capital (MPK) is 48 units per hour and the rental rate for capital is $8 per hour. Therefore, the value of the marginal product of capital is 48 units × output price.

The firm should continue to hire labor and rent capital up to the point where the value of the marginal product equals the market price of each input. In this case, the firm should compare the additional output value gained from an additional hour of labor with the wage rate, and the additional output value from an additional hour of capital with the rental rate. If the value of the marginal product is higher than the market price, the firm could benefit from using more of that input. Since the MPL and MPK are given and the wages and capital rental rates are also specified, the firm can calculate and compare these to decide on the optimal mix of labor and capital.