Chapter 3, Problem 1QQ

To determine

The correct answer.

Answer to Problem 1QQ

Option ‘a’ is the correct answer.

Explanation of Solution

Option (a):

The firm would employ labor and capital at the point where the marginal revenue product of labor and capital is equal to wage and rental price of capital. The marginal revenue product of labor can be calculated as follows:

$\begin{array}{c}{\text{Marginal revenue product}}_{\text{Labor}}=\text{MPL}\times \text{Price of good}\\ =5\times 5\\ =25\end{array}$

Marginal revenue product of labor is $25.

Marginal revenue product of capital can be calculated as follows:

$\begin{array}{c}{\text{Marginal revenue product}}_{\text{Capital}}=\text{MPK}\times \text{Price of good}\\ =40\times 5\\ =200\end{array}$

Marginal revenue product of capital is $200.

When increasing the quantity of labor and capital, it leads to reduce the marginal product of labor and capital, respectively, which in turn reduce the marginal revenue product of labor and capital. Thus, the firm would increase labor and capital till the point where the marginal revenue product of labor and capital is equal to wage and rental price of capital.

Thus, option (a) is correct.

Option (b):

When increasing the quantity of capital, it reduces the marginal product of capital and marginal revenue product of capital because of diminishing return. Thus, if the firm wants to maximize the profit, the manager should rent more capital. Thus, option (b) is incorrect.

Option (c):

When increasing the quantity of labor, it leads to reduce the marginal product of labor, which in turn reduces the marginal revenue product of labor and capital. Thus, if the firm wants to maximize the profit, the manager should hire more labor. Thus, option (c) is incorrect.

Option (d):

When increasing the quantity of labor and capital, it leads to reduce the marginal product of labor and capital, which in turn reduce the marginal revenue product of labor and capital. Thus, to maximize profit, the manager should increase both the quantity of labor and rent more capita. Thus, option (d) is incorrect.

Economics Concept Introduction

Marginal product of labor (MPL): It is the additional output a firm produces as a result of employing an extra unit of labor.

Marginal product of capital (MPK): It is the additional output a firm produces as a result of using an extra unit of capital.