# Marginal cost

4. The pencil industry is perfectly competitive. Each firm produces 10 million pencils per year. Pencils sell for 50 cents each and are produced at an average total cost of 30 cents each. What is the marginal cost of a pencil? Explain. Calculate the firm's profit.

5. An American company that sells consumer electronics products has manufacturing facilities in Mexico and Canada. In both countries, workers are hired within a perfectly competitive market. The average hourly wage and output for each country site are as follows:

Mexico Canada

Hourly wage rate $4.00 $15.00

Marginal Product of Labor 10 40

a. Given these figures, explain how you can tell the firm is not currently allocating its production resources optimally.

b. How should it adjust its resource allocation? What adjusts when it reallocates labor (i.e., wage or marginal product of labor) and why? Include an example of that the wage and marginal product of labor might be once the firm has completed allocating its resources optimally. [Note: You cannot know the true numbers but you can make them up for your example.]

c. (Unrelated to the first two parts) If a firm which uses capital (K) and labor (L) to produce some product finds that MPL/w > MPK/r, where w is the cost per unit of L and r is the cost per unit of K, should it substitute capital for labor? Explain.

#### Solution Preview

4. Given average total cost = 0.3 (dollar sign is omitted for easy calculation), then total cost = average total cost X quantity = 0.3Q, so marginal cost is the derivative of total cost, and hence 0.3.

A firm make 0.2 per pencil, and it sells 10 million pencils per year, so its profit = profit/unit X total number of units = 0.2 X 10 million = 2 million dollars.

5. In Mexico, workers are paid 4/hour ...

#### Solution Summary

Marginal cost