Question

A firm can borrow capital to invest and faces a marginal revenue (MR) as follows: 1st K has MR $2.50; 2nd K has MR $2.0; 3rd K has MR $1.60; 4th K has MR $1.45; 5th K has MR $1.38; and 6th K has MR $1.34. If the interest rate is 55%, then the firm's optimal demand for capital is

3

4

5

6

Answer 1

Option D is correct i.e. 6

Total revenue for each unit of capital = sum of all MRs uptill that unit

Total cost = interest * Total revenue

Profit = Total revenue - Total cost

Unit of capital	Marginal revenue	Total revenue	Total cost	Profit
1	2.5	2.5	1.375	1.125
2	2	4.5	2.475	2.025
3	1.6	6.1	3.355	2.745
4	1.45	7.55	4.1525	3.3975
5	1.38	8.93	4.9115	4.0185
6	1.34	10.27	5.6485	4.6215

Profit at the level of 6th unit of capital is the highest.