Question

A firm faces a Marginal Revenue schedule as follows: $2.1, $1.8, $1.4, $1.22, $1.05. If this firm faces an interest rate of 25%, then the firm will optimally demand _______ units of capital and the resulting total revenue is ______.

Answer 1

Firm will demand 3 units of capital.

Cost of each unit of capital= 1*(1+.25) =$ 1.25. (As interest rate is 25 %). This will be the cost of every additional capital. Firm will compare this cost with the marginal revenue.

Each unit will be profitable when marginal revenue is greater than marginal cost. As for the 4 unit onwards Marginal revenue is less than cost. Firm will not deploy additional capital.

Total revenue will be 2.1+1.8+1.4 = $5.3. i.e sum of marginal revenue of first 3 units.