Question

A manager of a perfectly competitive firm observes that the marginal product of labor is 5 units per hour, the marginal product of capital is 40 units per machine, the wage is $20 per hour, the rental price of capital is $120 per machine, and the price of output is $5 per unit. Please complete the following statement.
To maximize profit, the manager should hire _________and __________

Answer 1

Answer:

The manager should hire more labor and rent less capital.

Explanation:

Given:

MPL = Marginal product of labor units per hour = 5

MPC = marginal product of capital units per machine = 40

PL = Wage per hour = $20, or 20

PC = Rental price of capital per machine = $120, or120

Po = Price of output per unit = $5

The condition for the profit maximization for a firm is as follows:

MPL / PL = MPC / PC ……………………………. (1)

From equation (1), we have:

MPL / PL = 5 / 20 = 0.25

MPC / PC = 40 / 120 = 0.33

Since 0.25 = MPL / PL < MPC / PC = 0.33, it implies that these conditions are NOT consistent with equation (1).

In order to maximize profit, more labor should be hired while less capital should be rented until these conditions are consistent with equation (1).

Therefore, we have:

To maximize profit, the manager should hire more labor and rent less capital.