8. Explain how a firm sets its input level (labor). What is the adjustment process if...

8. Explain how a firm sets its input level (labor). What is the adjustment process if this input level is not reached?

Expert Solution

A firms sets its input level ( say labor ) based on marginal revenue product of labor , wage rate and the rule of MPL/PL=MPK/PK.

Firstly , firms hire labor till Marginal Revenue Product of Labor = Wage rate . When MPRL is greater than wage rate , firms hire more labor , so that diminishing marginal product sets in and they are equalized . They stop hiring as soon as the two values are equal . This point of equality is the labor market equilibrium .

Second , rule is the marginal decision rule . A firm will shift spending from one factor to another as long as the marginal benefit of such a shifting exceeds the cost of shifting . This is done in order to get the optimal factor combination . If the marginal benefit of additional labor, MPL/PL, exceeds the marginal cost, MPK/PK, then the firm will be better off by hiring more labor and less of capital . According to this rule, equilibrium in the labor market must occur where : MPL/PL=MPK/PK.

Rahul Sunny answered 1 year ago

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