In the short run, a particular type of skilled labor is the only variable factor
ID: 1221494 • Letter: I
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 - b L, where a and b are numbers to be specified below. The hourly wage is w, and each unit of output can be sold in a competitive market at a market price P. If w = $78, P = $25, a = 50, b = 2, and the firm is employing L = 22, then based on this information
a) The firm is using the optimal (profit-maximizing) amount of labor
b) The firm can increase its profits by reducing the amount of labor used
c) The firm can increase its profits by increasing the amount of labor used
d) The law of diminishing returns does not hold
Explanation / Answer
A firm is using optimal (profit-maximizing) amount of labor when,
MRP of labor = Wage rate
In given case,
MPL = a - bL = 50 - (22*2) = 50 - 44 = 6
P = $25
Calculate Marginal Revenue Product (MRP)
MRP = MPL * P = 6 * $25 = $150
Wage rate = $78
At present level of employment,
MRP > Wage rate
When MRP exceeds wage rate at current level of employment, firm can increase its profit by increasing the amount of labor used.
On the other hand, when MRP is less than wage rate at current level of employment, firm can increase its profit by reducing the amount of labor used.
In given case, at current level of employment, MRP exceeds wage rate.
So, the firm can increase its profit by increasing the amount of labor used.
Hence, the correct answer is option (c).