Optimal Combination of Resources
• When operating in the Long-run a firm can
change its capital and its labor.
• Every firm has to decide what combination of
labor(L) and capital(K) they should employ.
The Least-Cost Combination of Resources
• A firm would like to produce the most output
possible for a given resource budget
• A firm also wants to produce a given level of
output at the lowest total coast
• To accomplish this it should allocate its resource
budget between units of labor and units of
capital to satisfy the following:
(MPP=Marginal Physical Product) (MRC=Marginal Resource Cost)
Least Cost Combination (Perfectly Competitive)
• If the resource markets are perfectly competitive,
the price the firm pays for an extra unit of a
resource is equal to MRC. In this case:
(P ) is the price of a unit of labor
(P ) is the price of a unit of capital
Profit Maximizing Combination of Resources
• A firm cannot maximize its profits without using
the least-cost combination of resources.
• An additional condition must be satisfied to
guarantee that profits are maximized.
It looks similar to the Least-Cost Combination of Resources 2 differences
1. The firm is comparing MRP, not MPP, to MRC
2. The two rations must both be equal to 1.
Profit Maximizing Combination (Perfectly Competitive)
• If the resource markets are perfectly competitive,
the condition can be written as