Your firm produces clay pots entirely by hand even though a pottery machine exists that can make clay pots faster than a human. Workers cost $80 per day and each additional worker can produce 20 more pots per day (i.e., marginal product is constant and equal to 20). Installation of the first pottery machine would increase output by 300 pots per day. Currently your firm produces 1,800 pots per day.
a. Your financial analysis department estimates that the price of a pottery machine is $2,000 per day. Can you reduce the cost of producing 1,800 pots per day by adding a pottery machine to your production process and reducing the amount of labor? Explain why or why not.
b. If a labor union negotiates higher wages so that labor costs rise to $160 per day, does this change your answer to part a? Explain.
c. Suppose your firm wants to expand output to 2,500 pots per day and input prices are $100 and $2,000 per day for labor and capital, respectively. Is it efficient to hire more labor or more capital? Explain.
Without the pottery machine, our firm is producing 1800 pots per day. Each worker produces 20 pots, so we must be using 90 workers. Each worker costs $80, so our total cost is $7200.
With the pottery machine producing 300 pots, we only need 75 workers to produce 1500 pots. Our costs are ...
This solution shows how to calculate the marginal product of labour and capital. Using this information, decisions can be made whether to increase the amount of labour or capital at a firm.