Suppose a firm hires both labor (L) and capital (C) under purely competitive conditions.The price of labor is PL, and that of capital is PC.The marginal product of labor is MPL, and that of capital is MPC.The firm sells its product competitively at a price of PX.If MPC / PC MPL / PL, the firm
A)may be maximizing profits, but it is not minimizing costs.
B)may be minimizing costs, but it is not maximizing profits.
C)is neither minimizing costs nor maximizing profits.
D)is minimizing costs and maximizing profits.

Question

Suppose a firm hires both labor (L) and capital (C) under purely competitive conditions.The price of labor is PL, and that of capital is PC.The marginal product of labor is MPL, and that of capital is MPC.The firm sells its product competitively at a price of PX.If MPC / PC > MPL / PL, the firm
A)may be maximizing profits, but it is not minimizing costs.
B)may be minimizing costs, but it is not maximizing profits.
C)is neither minimizing costs nor maximizing profits.
D)is minimizing costs and maximizing profits.

Quizplus · Accepted Answer

The firm is not maximizing profits because it can increase output by reallocating resources from labor to capital, as capital is more productive per dollar spent. It is also not minimizing costs because the ratio of marginal product to price is not equal for labor and capital.

Suppose a Firm Hires Both Labor (L) and Capital (C)