Suppose the marginal rate of technical substitution for labour with capital is 5,the marginal product of labour is 8 and the marginal product of capital is 4.Assuming the law of diminishing marginal product applies to both labour and capital,this firm
A) Is minimizing the cost of producing its output
B) Could reduce costs by substituting workers with capital
C) Could reduce costs by substituting capital with workers
D) Could reduce the cost of producing the output by reducing workers and capital by the same proportion

Question

Quizplus · Accepted Answer

The marginal rate of technical substitution (MRTS) is the ratio of marginal product of labour to marginal product of capital. In this case, MRTS = 5, MP of Labour = 8, and MP of Capital = 4. Since MRTS > MP of Labour/MP of Capital, it implies that the firm can produce the same output with fewer workers and more capital. Therefore, the firm could reduce costs by substituting workers with capital, making choice B the correct answer.

Suppose the Marginal Rate of Technical Substitution for Labour with Capital