Economics (McConnell), 18th EditionChapter 2:
The Market System and the Circular FlowWorked Problems (19.0K)
Problem 2.1 - Least-cost production Resource | Price per Unit of Resource | Resources Required | Technique 1 | | Technique 2 | | Technique 3 | Units | | Units | | Units | Land | $2 | 2 | | 2 | | 3 | Labor | $4 | 3 | | 2 | | 1 | Capital | $3 | 1 | | 2 | | 3 | Entrepreneurial Ability | $5 | 1 | | 1 | | 1 |
Problem: Suppose there are three techniques for producing 1 wool blanket, as shown in the table above. - With the resource prices shown, which production technique will the firm use? Why?
- Suppose the firm can sell blankets for $26 each. Will the firm be profitable?
- Assume a new technique is developed that economizes on the relatively expensive labor. It requires 2 units of land, one unit of labor, 3 units of capital, and 1 unit of entrepreneurial ability. Will the firm adopt this new technique?
- Suppose the firm's cost of capital rises to $5, all other values being the same. Which technique will the firm now choose?
| Answer: - The firm will choose technique 2. Its land cost is $2x2 = $4, its labor cost is $4x2 = $8, its capital cost is $3x2 = $6, and the cost of its entrepreneurial ability is $5x1 = $5, for a total cost of $4 + $8 + $6 + $5 = $23. By comparison, each of the other techniques have a total cost of $24.
- Yes—If each blanket sells for $26 and can be produced for $23, the firm will make $3 profit on each one.
- Yes—The cost of producing a blanket would fall to $2x2 + $4x1 + $3x3 + $5x1 = $22. This is $1 cheaper than its current production technique.
- Technique 1 is now cheapest, with a total cost of $26. By contrast, techniques 2, 3 and 4 now cost $27, $30, and $28, respectively.
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