Consider the following scenario: the firm estimates that currently, its marginal product of labor is 40, while the marginal product of capital is 160. The firm pays $40 in the rental price of capital and $15 in wage. Can this firm improve its profits by adjusting its labor and capital combination while holding the overall costs of production constant? And if yes, how? (Assume the standard assumptions about the production function, i.e. diminishing marginal products).
A) No, as the firm optimizes its production already.
B) Yes, the firm should reduce its labor level and increase its capital stock.
C) Yes, the firm should reduce its capital stock and increase its labor level.
D) Not enough information is provided.

Question

Quizplus · Accepted Answer

The firm can improve its profits by adjusting its labor and capital combination because the marginal product per dollar spent on capital (160/40 = 4) is higher than the marginal product per dollar spent on labor (40/15 ≈ 2.67). Therefore, reallocating spending from labor to capital will increase output per dollar spent, assuming diminishing marginal returns don't immediately offset the gains.

Consider the Following Scenario: the Firm Estimates That Currently, Its