A firm is currently hiring capital and labor so that MP_L/P_L

Question

A firm is currently hiring capital and labor so that MP_L/P_L < MP_K/P_K, if the firm wishes to maximize profits it should hire A) less labor and less capital. B) more capital and more labor. C) more labor and less capital. D) less labor and more capital.

Quizplus · Accepted Answer

The ratio MP_L/P_L represents the marginal productivity of labor (MPL), which is defined as the additional output produced by one additional unit of labor. Similarly, the ratio MP_K/P_K represents the marginal productivity of capital (MPK), which is defined as the additional output produced by one additional unit of capital. The firm should hire more of the factor that has a higher marginal productivity per unit of cost (i.e., a higher MP per dollar spent). In this case, since MP_L/P_L < MP_K/P_K, it means that the MP per dollar spent on capital is higher than the MP per dollar spent on labor. Therefore, the firm should hire more capital and less labor, so the answer is D) less labor and more capital.

A Firm Is Currently Hiring Capital and Labor So That