Suppose that a firm that maximizes profits observes the following:

𝑀
𝑃
𝐿

Question

Suppose that a firm that maximizes profits observes the following:

𝑀
𝑃
𝐿
<
𝑤

Select the correct statement(s) that characterize(s) the optimal firm's behavior. (Select all that apply)

BlackTom AI · Accepted Answer

The question asks how a profit-maximizing firm should behave when the observed marginal product of labor is less than the wage rate (MP_L < w). This situation indicates that labor is currently overused relative to its contribution to output, so the firm would want to adjust input mix to restore profitability.
Option 1: The firm could rent more machines to compensate for this situation.
- Since MP_L < w, labor is relatively expensive given its contribution to output, suggesting a substitution away from labor toward capital where possible. If the firm can substitute capital for some labor by renting additional machines, it can raise the marginal product per dollar spent and potentially increase output or reduce costs, helping to offset the low marginal productivity of labor. This rationale rests on the substitutability between labor and capital and the ability to scale capital inputs in the short or long run.
- A potential caveat is that renting more machines also adds fixed or variable costs, so the firm must ensure the expected increase in output or reduction in average costs justifies the additional capital expenditure. Nonetheless, the core idea is that, to optimize profits when MP_L is too low, increasing capital input can be an effective counterbalance.
Option 2: The firm optimally decides to fire workers.
- Reducing the number of workers directly targets the input whose marginal product is below its cost, which is a textbook move when MP_L < w: trimming the input whose return does not cover its expense should improve profitability. Firing workers reduces labor costs and can bring the marginal cost of production back in line with the marginal revenue product of labor.
- This action aligns with profit-maximization logic in both short and long run analyses, provided that there are not other constraints (e.g., morale, startup costs, training for replacement workers). It reflects the intuition that if each additional unit of labor yields less additional output than its wage, you should cut back on labor until MP_L rises or output falls less than costs.
Both options are consistent with the social science intuition that, when MP_L < w, the optimal response involves reallocating or reducing labor usage to improve profitability. The choice to rent more machines emphasizes substituting capital for labor, whereas firing workers emphasizes reducing the costly, low-yield input directly. The exact path may depend on the firm’s production technology, costs of renting versus laying off, and the substitutability between capital and labor in the production process.

ECON 13210 94 Introduction to Macroeconomic Models Midterm Exam

Suppose that a firm that maximizes profits observes the following: 𝑀 𝑃 𝐿 < 𝑤 Select the correct statement(s) that characterize(s) the optimal firm's behavior. (Select all that apply)

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