Question

explain the pricipal of marginal productivity as a means to optimize profits by optimal resource use. explain in terms of our different favtors of production (land, labor, and capital) and how firms will choose how much input to employ

Answer 1

Marginal Productivity Theory

Marginal product refers to the increase in amount of output by the addition of one unit of factor of production( Land, Labor and capital ) . The increase in the output with the addition of one unit of factors of production is known as marginal productivity.

In order to find the level of input ( factors of production ) to achieve the  profit optimization level of output , let us assume  land and capital as constant and consider labor as variable input.

Marginal Revenue Product :

The demand curve for labor tell us how many workers a firm will employ at a given wage rate in a given time period. The demand curve of labor is derived from the estimated marginal revenue product of Labor ( MRPL).

MRPL is the extra revenue generated when an additional worker is employed. Therefore ,

MRPL= Marginal product of Labor * Marginal Revenue .-- 1

Marginal Revenue Product Calculation

Units of Labor employed	Total output of labor per week	Marginal Product	Price= AR= MR($)	Marginal Revenue Product of Labor($)
1	10	10	20	200
2	24	14	20	280
3	44	20	20	400
4	60	16	20	320
5	72	12	20	240
6	80	8	20	160
7	84	4	20	80

We are assuming that the firm employing labor is operating in a perfectly competitive market so that each unit of output sold generates a revenue of $ 20. Therefore Average Revenue = Marginal Revenue.

Marginal Product is calculated by taking the change in total output of labor per week/ change in units of labor .

MRPL = Marginal Product * Marginal Revenue ( from 1 )

Therefore MRPL curve is the demand curve for labor, MRPL falls when the diminishing returns set in.( represented as BOLD).

Also let us assume that each extra worker employed costs the firm $160 per day, this is called the Marginal Cost.

Therefore, firms optimizes profit at the point where Marginal Cost equals MRPL . Here, in the above case at 6 units of labors are employed the wage rate is $ 160.