Optimal Combination of Resources

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Presentation transcript:

Optimal Combination of Resources When operating in the Long-run a firm can change its capital and its labor. Every firm has to decide what combination of labor(L) and capital(K) they should employ.

The Least-Cost Combination of Resources A firm would like to produce the most output possible for a given resource budget A firm also wants to produce a given level of output at the lowest total coast To accomplish this it should allocate its resource budget between units of labor and units of capital to satisfy the following: (MPP=Marginal Physical Product) (MRC=Marginal Resource Cost)

Least Cost Combination (Perfectly Competitive) If the resource markets are perfectly competitive, the price the firm pays for an extra unit of a resource is equal to MRC. In this case: (P ) is the price of a unit of labor (P ) is the price of a unit of capital

Profit Maximizing Combination of Resources A firm cannot maximize its profits without using the least-cost combination of resources. An additional condition must be satisfied to guarantee that profits are maximized. It looks similar to the Least-Cost Combination of Resources 2 differences The firm is comparing MRP, not MPP, to MRC The two rations must both be equal to 1.

Profit Maximizing Combination (Perfectly Competitive) If the resource markets are perfectly competitive, the condition can be written as