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(Business example of last dollar rule. Assume that we have normal convex isoquants). Suppose you are...

(Business example of last dollar rule. Assume that we have normal convex isoquants). Suppose you are running a business and face a low skill wage rate of $9 per hour and a high skill wage rate of $18 per hour. If the marginal product of low skill labor for your business is 50 units of output per hour, and the marginal product of capital is 75 units of output per hour, are you using the cost-minimizing combination of the two types of labor? Explain. If not, should you increase or decrease the amount of low skill labor that you use relative to the amount of high skill labor?

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Answer #1

We have a low skill wage rate of $9 per hour and a high skill wage rate of $18 per hour.

MP of low skill labor = 50 units of output per hour,

MP of capital = 75 units of output per hour

For cost-minimizing combination of the two types of labor, you must ensure that MPL/MPK = PL/PK

Here MPL/MPK = 50/75 = 2/3 and PL/PK = 9/18 = 1/2

Here MPL/MPK > PL/PK

This indicates that the additional product per dollar of the low skilled worker is greater than the additional product per dollar of the high skilled worker. Therefore you should increase the use of low skilled worker and decrease the use of high skilled worker

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