2. Assume that both labor and capital exhibit diminishing returns. Suppose you c

Question

2. Assume that both labor and capital exhibit diminishing returns. Suppose you can hire an additional unit of labor for $10, and she can product 50 units. You could also buy an additional machine at the cost of $200, and that machine would allow you to produce 1000 units.

If your main concern is minimizing average cost, what should you do?

a) Buy the machine, because it will allow you to produce more

b) Nothing, because you are already minimizing cost

c) There is not enough information to make a legitimate response

d) Hire more labor, because it is cheaper

Explanation / Answer

Contribution of additional labor towards the average cost = 10/50

= 0.2

Contribution of additional machine towards the average cost = 200/1000

= 0.2

Hence, both options influence the average cost equally.

Hence right answer is (B)

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