Consider a firm using labor and capital as its only inputs. The price of capital

Question

Consider a firm using labor and capital as its only inputs. The price of capital is $40 where the price of labor (wage) is $60. Using 500 units of labor and 500 units of capital the firm is producing 1200 units of output. At this mix of input the firm's MPL is 10 while its MPK is 5.

a. Write the firm's isocost equation. What is the slope of the isocost?
b. Determine if the firm's mix of inputs is optimal. Explain.
c. If your answer to "b" is no, what should the firm do to improve its performance? Explain.
d. Now suppose as a result of a mandated increase in the minimum wage the wage increases to $80. What would be the implication of this change for this firm?

Explanation / Answer

a) The equation is

1200X= 40k+60L

slope= 2/10=0.2

b) Firm's mix of inputs is not optimal as the demand is elastic and it can still produce more.

c) The firm should decrease labour and increase capital as demand for labour is inelastic

d) If wage increases, firm should invest more capital. Hence supply would increase.

By

Nishant Bhatt

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