Question for Best answer's explanation.

I don't understand

"To achieve maximum output;

MPK/MPL=PK/PL

60/20=6/2.5

3=2.4".

Does it mean the Marginal Productivity of Capital is 3, and the Marginal productivity of labor is 2.4, then they should be allocated per dollar?

[Question]

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Suppose a firm finds that the marginal product of capital is 60 and the marginal product of labor is 20. If the price of capital is $6 and the price of labor is $2.50, describe how the firm should adjust its mix of capital and labor? What will be the result?

Answer and Explanation

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Solved by verified expert

The marginal benefit of capital is greater than the marginal benefit of labor. Labor needs to be moved to the capital for greater productivity.

The marginal product of labor will increase while the marginal product of capital will decrease. This will lead to higher productivity of the firm since it will be on a higher isoquant than in the beginning.

Step-by-step explanation

MPK/PK=60/6=10

MPL/PL=20/2.5=8

The marginal benefit of capital is greater than the marginal benefit of labor. Labor needs to be moved to the capital for greater productivity.

To achieve maximum output;

MPK/MPL=PK/PL

60/20=6/2.5

3=2.4

This shows that labor needs to be moved to capital so that the marginal product of labor will increase, while the marginal product of capital will decrease. The left-hand side to the right-hand side and this will lead to higher productivity of the firm since it will be on a higher isoquant than in the beginning.

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