Suppose a competitive firm produces 100 units of X for a price of Rs.10 a unit. The firm is employing labour and capital such that the marginal physical product of labour and capital is 20 and 5 and the prices paid to labour and capital are Rs. 60 and Rs. 40 respectively. How would you characterize the firm
A)the firm is in long-run equilibrium
B)the firm is earning excess profits
C)the firm should expand production
D)the firm should contract production

Question

Quizplus · Accepted Answer

The firm should expand production because the marginal revenue product (MRP) of labor and capital is greater than their respective costs. MRP is calculated as the marginal physical product (MPP) multiplied by the price of the product. For labor, MRP = 20 * 10 = Rs. 200, which is greater than the price paid to labor (Rs. 60). For capital, MRP = 5 * 10 = Rs. 50, which is also greater than the price paid to capital (Rs. 40). This indicates that the firm can increase its profits by employing more labor and capital.

Suppose a Competitive Firm Produces 100 Units of X for a Price