In: Economics
Suppose you are the manager of a firm producing soap. In the long-run, you are deciding from which of the following three production processes to choose your production method. Your wish, in order to maximize profits, is to choose the most economically efficient method of production that produces 100 units of soap per day.
Method | Units of Labor | Units of Capital | Labor Cost | Capital Cost |
Capital Intensive | 1 worker | 5 machines | ||
Even Split | 3 workers | 3 machines | ||
Labor Intensive | 6 workers | 1 machine |
If the cost of hiring labor is $50 per worker and the cost of using capital equipment is $60 per machine, fill in the total labor cost and total capital cost in the above table.
Remembering the concept of average total cost from Chapter 5, which production method yields the lowest per unit cost of output, and hence, the economically efficient method of production for 100 units of soap?
The total cost of labor for the firm at $50 per worker is
The total cost for capital is at the rate of $60 per machines is
Using these formulas the table is completed as
Method | Units of Labor | Units of Capital | Cost of Labor | Cost of capital |
Capital Intensive | 1 | 5 | 50 | 300 |
Even Spit | 3 | 3 | 150 | 180 |
Labor Intensive | 6 | 1 | 300 | 60 |
The total cost of production is the total cost of capital and labor. This is calculated in the table in the Total cost column. The average cost per unit is then calculated by dividing the total cost by 100.
Method | Total Cost | The average cost per unit for 100 units |
Capital Intensive | 350 | 3.5 |
Even Spit | 330 | 3.3 |
Labor Intensive | 360 | 3.6 |
The average cost per unit is lowest or minimum for the production method Even Split. Therefore, the economically efficient methos is "Even Spit".