Question

The current wage rate is $\backslash (10$, and the rental rate of capital is $\backslash )500$. A firm's marginal product of labor is $200$, and its marginal product of capital is $20,000$ . Is the firm maximizing profits for the given cost outlay? Why or why not?

Short answer

To increase the additional output per dollar spent on labour, the firm should reduce the number of units it hires. By increasing capital use to the point where the amounts equalize, it should reduce the additional output per dollar spent on capital.

Step-by-step solution

Introduction.

A company maximizes profits by operating at the point where marginal revenue equals marginal cost.

According to neoclassical theory, a firm maximizes profit in order to determine a level of output and inputs that meets the price equals marginal cost condition.

Given Information.

The following are the information given as:

The current wage rate is $\$10$

The rental rate of capital is$\$500$

A firm's marginal product of labor is $200$

marginal product of capital is$20000$

Marginal Physical Product.

The MPP of labor per dollar spent on wages is $20$units

$(200/10=20).$

The MPP of capital per dollar spent on capital is $40$units

$(20,000/500=40).$

Thus, the MPP of labor per dollar spent on wages is less than the MPP of capital per dollar spent on capital.

The firm maximizing profits for the given cost. 

As a result, the firm should reduce the number of units it hires in order to increase the additional output per dollar spent on labour.

Simultaneously, it should reduce the additional output per dollar spent on capital by increasing capital use to the point where the amounts equalize.