Question

Suppose that a perfectly competitive firm is currently producing 100 units of output. If the short-run marginal cost of producing the 100^th unit is greater than the price at which that unit can be sold, how must this firm alter its labor input in order to maximize profit

Answer 1

Answer: Layoff labor input.

A perfectly competitive firm maximizes its profit at the level of output where marginal revenue(MR) is equal to the marginal cost(MC) of production. In perfectly competitive market, the firms are price taker; and the marginal revenue of a firm is equal to the market price.

Thus from the above we see that, at the profit maximizing level of output of the firm, the MR = MC = Price.

Now here, a perfectly competitive firm is producing 100 units of output, at which, the marginal cost of producing the 100^th unit is greater than the price at which that unit can be sold, i.e., at the 100^th unit of output, the MC is greater than the MR, as MR is equal to the price. Thus the firm is making loss at the 100^th unit of output. In this case, in order to maximize profit, the firm must reduce the level of output and the marginal cost of production. The firm can do this, if it decreases the number of workers, i.e., laying off employees.

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