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March 30, 2017

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The current market wage rate is $10, the rental rate of land is $1,000 per unit, and the rental rate of capital is $500. Production managers at a firm find that under their current allocation of factors of production, the marginal revenue product of labor is 100, the marginal revenue product of land is $10,000, and the marginal revenue product of capital is $4,000. Is the firm maximizing profit?

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    Maximizing profits? No. For any given level of capital (or land, or anything else), the Marginal Revenue Product of Labor must be equal to its Marginal Cost (or the wage rate if we assume the labor market is competitive).

    Given the numbers above, $100 > $10 (this basically says the next worker brings in $100 to the firm, but only costs them $10). They could still hire more workers at $10, and have them bring in more money (although the $100 would drop for each new worker due to diminishing returns). It falls all the way down to 10 (when 10 = 10) and you won't hire anymore workers (because the next worker would cost you $10, but he would bring in something lower than $10... why hire him then?).

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