Consider a company that produces dog toys. The only resources that the company u
ID: 1227465 • Letter: C
Question
Consider a company that produces dog toys. The only resources that the company uses to produce these toys are Capital (i.e. machines and raw materials) and Labor (i.e. workers). The company sells 10,000 toys a month at $100 per toy. The company’s own internal research shows 60% of the revenue is from the use of the Capital and the other 40% of the revenue is from the use of the Labor. The unit cost of Capital is $40 and the unit cost of Labor is $50. The toy company’s production budget is $900,000.
(a) Write down the toy company’s budget equation and show it on a well-labeled graph (put Labor on the y-axis).
(b) If the toy company is to hire 10,000 units of the Capital, what would be the maximum number of workers that the company can hire?
(c) What would be the opportunity cost of Labor in terms of Capital? What does this opportunity cost tell us in this example?
(d) At the current condition (i.e. given the above information), is the company satisfying the “Golden Mean” condition? Please explain why or why not. If not, what adjustment the company should make?
Explanation / Answer
(a) Budget line shows combination of two goods which a person can consume with his given income. Budget line equation:
Px.X + Py.Y = M
here, Px = Price of Capital
X is the units of capital
Py is the price of Labor
Y is the units of labor
40X + 50Y = $ 900,000
4X + 5Y = 90,000
(b) If company hires 10,000 units of capital then, expenditure of company is $ 40 X 10,000 = $ 400,000
Remaining amount left with company = $ 900,000 - 400,000 = 500,000
Maximum number of workers that the company can hire = 500,000/50 = 10,000 workers
(c) MRS = Price of Capital / Price of Labor = $ 40 / $ 50
MRS = 4/5 = 0.8
It shows that to gain 1 unit of labor, firm has to sacrifice 0.8 units of capital.
Opportunity cost shows the value of next best alternative forgone.
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.