TAILIEUCHUNG - Ten Principles of Economics - Part 40

Ten Principles of Economics - Part 40. Economics is the study of how society manages its scarce resources. In most societies, resources are allocated not by a single central planner but through the combined actions of millions of households and firms. Economists therefore study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings. Economists also study how people interact with one another. | CHAPTER 18 THE MARKETS FOR THE FACTORS OF PRODUCTION 403 FYI Input Demand and Output Supply Two Sides of the Same Coin In Chapter 14 we saw how a competitive profit-maximizing firm decides how much of its output to sell It chooses the quantity of output at which the price of the good equals the marginal cost of production. We have just seen how such a firm decides how much labor to hire It chooses the quantity of labor at which the wage equals the value of the marginal product. Because the production function links the quantity of inputs to the quantity of output you should not be surprised to learn that the firm s decision about input demand is closely linked to its decision about output supply. In fact these two decisions are two sides of the same coin. To see this relationship more fully let s consider how the marginal product of labor MPL and marginal cost MC are related. Suppose an additional worker costs 500 and has a marginal product of 50 bushels of apples. In this case producing 50 more bushels costs 500 the marginal cost of a bushel is 500 50 or 10. More generally if W is the wage and an extra unit of labor produces MPL units of output then the marginal cost of a unit of output is MC W MPL. This analysis shows that diminishing marginal product is closely related to increasing marginal cost. When our apple orchard grows crowded with workers each additional worker adds less to the production of apples MPL falls . Similarly when the apple firm is producing a large quantity of apples the orchard is already crowded with workers so it is more costly to produce an additional bushel of apples MC rises . Now consider our criterion for profit maximization. We determined earlier that a profit-maximizing firm chooses the quantity of labor so that the value of the marginal product P x MPL equals the wage W . We can write this mathematically as P X MPL W. If we divide both sides of this equation by MPL we obtain P W MPL. We just noted that W MPL equals marginal cost .

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