Question

Assume that a business firm finds that its profit is greatest when it produces $40 worth of a product A. Suppose also that each of the three techniques shown in the following table will produce the desired output.

A. With the resource prices shown, which technique will the firm choose? Why? Will production using that technique entail profit or loss? What will be the amount of that profit or loss? Will the industry expand or contract? When will that expansion or contraction end?

b. Assume now that a new technique, technique 4, is developed. It combines 2 units of labor, 2 of land, 6 of capital, and 3 of entrepreneurial ability. In view of the resource price in the table, will the firm adopt the new technique? Explain your answer.

c. Suppose that an increase in the labor supply causes the price of labor to fall to $1.50 per unit, all other resource prices remaining unchanged. Which technique will the producer now choose? Explain.

d. "The market system causes the economy to conserve most of the use of resources that are particularly scarce in supply. Resources that are scarcest relative to the demand for them have the highest prices. As a result, producers use these resources as sparingly as is possible." Evaluate this statement. Does your answer to part c, above, bear out this contention? Explain.

Answer 1

			Resource Units Required
Resource	Price per unit of resource		Technique 1	Technique 2	Technique 3
Labor Land Capital Entrepreneurial                                      ability	$3 4 2 2		5 2 2 4	2 4 4 2	3 2 5 4

(a) The firm will choose technique 2 because it produces the output at the least cost ($34 compared to $35 for techniques 1 and 3). Economic profit will be $6 (= $40 - $34), causing the industry to expand. Expansion in this industry will continue until prices decline to where total revenue equals total cost of $34 and no additional firms will want to enter the industry.

(b) The firm will adopt technique 4 because its cost is now lowest at $32.

(c) The firm will choose technique 1 because its cost is now lowest at $27.50.

(d)       The statement is logical. Increasing scarcity of a resource causes its price to rise. Firms ignoring higher resource prices will become high-cost producers. Firms switching to the less expensive inputs become lower-cost producers and earn higher profits than high-cost producers. The market system, therefore, forces producers to conserve on the use of highly scarce resources.