Author Question: Explain why in the long run a firm that is cost minimizing will choose K and L where: w/MPL = ... (Read 71 times)

berenicecastro · **on:** Jul 1, 2018

Explain why in the long run a firm that is cost minimizing will choose K and L where:

w/MPL = r/MPK
What does this tell you about the marginal cost of increasing output through hiring labor and the marginal cost of increasing output through adding capital?

Question 2

A firm's private costs

A) include only its direct costs.
B) is the private profit minus the producer surplus.
C) include both direct and indirect costs.
D) exclude the taxes on any externalities generated.

Dinolord · **Reply #1 on:** Jul 1, 2018

Answer to Question 1

This is just a simple rearrangement of the cost-minimization condition MRTS = w/r. Because MRTS = MPL/MPK, then rearranging gives the condition above. For a firm in the long run minimizing costs, if the firm wishes to increase output it can do so by adding labor or capital (or both). The condition above says the cost of an additional unit of output (Q) from increasing labor must equal the cost of increasing output from increasing capital. Intuitively, if this were not the case, the firm could reduce output by lowering the input corresponding to the higher marginal cost and replace that output by increasing the input correspond to the lower marginal cost. Doing so would reduce the overall cost without sacrificing output.

Answer to Question 2

A