Question

Assume a firm has 2 inputs in its production​ function, labor and​ capital, and can adjust the amount of either one of these inputs in order to increase output. Assume the marginal product of a unit of capital is always twice as high as the marginal product of a unit of labor​ (this is true regardless of how much labor and how much capital the firm​ employs). If the firm wanted to expand​ output, would they ever do so by increasing the amount of labor​ employed? Why or why​ not?

Answer 1

The marginal product of capital bring twice the marginal product of labour implies that each additional input of capital adds to the total product twice than what each additional unit of labour adds. In this situation, it may seem efficient to employ only capital to raise output as it is twice as productive. However, this depends upon the cost of the input. If cost of employing that unit of capital exceeds two times the cost of labour, then there is no actual benefit from the higher productivity of capital because the producer is having to pay much more for attaining the higher production.

For example: 1 additional unit of capital costs 1000 and adds 10 units to the output. And 1 additional unit of labour costs 200 and adds only 5 units of output. Here, although marginal product of capital is higher, the producer can employ 5 units of labour at the same cost as one unit of labour and hence get a higher level of production.

Hence, decision of input employment is contingent upon the cost of input also.

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