A firm using MEc tools finds that the 2-inputs in its 2-input production arrangement is inefficient....

A firm using MEc tools finds that the 2-inputs in its 2-input production arrangement is inefficient. Describe how that inefficiency is manifested in terms of the inputs and spending. Also, briefly discuss the choice the firm faces with regard to outputs OR its budgetary outlays devoted to production. How could it spend less with the same budget?

Expert Solution

This kind of inefficiency is known as productive inefficiency. An optimal rules to be followed is the equimarginal principle. Accordingly the optimum input mix must ensure that the marginal product of each input when divided by its price should be equal across all the inputs. This indicates that if there are inputs such that their marginal product at the current level of usage divided by their prices is greater than the ratio of the marginal product upon prices of other inputs, then the firm should use more of these inputs.

Take labour and capital for example. If the ratio of the marginal product of labour to the wage rate is greater than the ratio of the marginal product of capital to the rental price, then labour is considered to be more productive than capital and the firm should employee more labour and less capital. This will indicate that under the same budget the firm can reduce the number of capital units and increase the number of labour units thereby reducing the total spending.

Rahul Sunny answered 2 years ago

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