Question

In the short run, a particular type of skilled labor is the only variable factor used by a firm. The manager of the firm has estimated that the marginal product of labor is given by MPL = A / (√L), where A is a number to be specified below (and √ represents the square root). The hourly wage is w, and each unit of output can be sold in a competitive market at a market price P. If w = $70, P = $30 and A = 24 and the firm is using L = 144 then based on this information

a) The firm is using the optimal (profit-maximizing) amount of labor.

b) The firm can increase its profit by reducing the amount of labor used.

c) The firm can increase its profit by increasing the amount of labor used.

d) The law of diminishing returns does not hold, so it is not possible to determine whether the firm should increase, decrease or not change the amount of labor being used.

Answer 1

b) The firm can increase its profit by reducing the amount of labour used.

This happens because MPL would decrease as we increase L so it means the law of diminishing marginal returns is operating. As marginal product decreases by employing an additional factor, Marginal Cost starts to increase which means total cost would increase and marginal product is declining which means Total ouput produced by each additional worker would start declining so the difference between total revenue and total cost would start declining thus profits would start to fall. So, profits could be increased by reducing the amount of labor used.