One economic question is deciding how to produce. That means businesses need to make decisions on...

One economic question is deciding how to produce. That means businesses need to make decisions on what types of production systems and what types of inputs to use. The isoquant/isocost model allows us to conceptualize the answer(s) a business might have for the question of how to produce. The relative price inputs plays a role in answering the question of how to produce.

There may appear to be times when a firm does not appear to adjust input use to changes in relative prices of inputs. Explain why this might be the case.

Expert Solution

Pricing decisions taken by the firms usually involve analysis regarding marginal contributions to revenues and costs. The firms achieve their aim of profit maximization by increasing their production until marginal revenue is equal to marginal cost and then the price which is determined by the demand curve is charged.

A marginally diminishing rate of production return per unit produced can be seen after the adjustments to inputs driving production are made. This is known as diminishing marginal productivity.

As per the law of diminishing marginal productivity, the changes to inputs will have a marginally positive effect on outputs. Hence, each additional unit produced will result in a marginally smaller production return than the unit before it.

Diminishing marginal productivity can lead to a loss of profit after crossing the threshold. If this occur, there will not be any cost improvement per unit with the increase in production. As a result, there is no return gained for units produced and losses can increase as more units are produced.

Thus, a firm does not appear to adjust input use to changes in relative prices of inputs.

Rahul Sunny answered 6 months ago

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