Question

Consider the following cost information for a firm that operates in a perfectly competitive market.   Labor is a variable input.

Q (quantity of output)	Total cost ($)
0	15
1	25
2	45
3	75
4	110
5	165
6	225

(1) As the firm increase the output from 1 unit to 2 units, does the marginal product of labor rise or fall?   Explain.

(2) Suppose that the market price is $30. Find the optimal quantity of output that the firm should produce in the short run.    

(3) Suppose that the market price drops from $30 to $20. Find the quantity of output that the firm should produce in the short run.

Answer 1

Table with Marginal cost

MC =dTC/dQ

Q (quantity of output)	Total cost ($)	Marginal Cost
0	15	--
1	25	10
2	45	20
3	75	30
4	110	35
5	165	55
6	225	60

(1) As the output increases from 1 unit to 2 units, the MC rises. This implies that the marginal product of labor has fallen. MPL and MC are inversely related to each other. This is due to decreasing returns.

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(2) Suppose Price = $30

The firm should produce 3 units.

In perfect competition, P = MC = MR.

This will maximize profits.

Q (quantity of output)	Total cost ($)	Marginal Cost
0	15	--
1	25	10
2	45	20
3	75	30
4	110	35
5	165	55
6	225	60

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(3) Suppose Price = $20

The firm should produce 2 units.

In perfect competition, P = MC = MR

This will maximize profits.

Q (quantity of output)	Total cost ($)	Marginal Cost
0	15	--
1	25	10
2	45	20
3	75	30
4	110	35
5	165	55
6	225	60