Optimal use of Variable Input
Knowledge of marginal products of inputs enables managers to determine the short run optimal employment of capital and labour in the production process, suppose the MPL of an additional worker is 4 units of output and each unit is worth Rs 10,000. Thus the additional revenue to the firm will be Rs 40,000 if a worker is hired. It the additional cost of worker (i.e. the wage rate) is Rs 30,000 then the worker hired 'will contribute Rs 10,000. However if the wage rate is Rs 45,000 the worker should not be hired because profits will reduce by Rs 5,000. Thus, the basic principle is that, to maximise total profits, variable input should be hired
- As long as the marginal revenue product of the input is greater than the marginal resource cost of the variable input (MRPL > MRCL).
- Until the MRPL = MRCL.
The marginal revenue product (MRP) is defined as the product of marginal revenue (MR) and marginal product (MP) of the variable input. That is
MRPL = (MR) (MPL)
Thus labour is hired until MRPL = w. Similarly, if the labour input is fixed and the capital stock could be varied, capital would be employed until MRP K equals the price of capital or rent (r), i.e. MRPK = r.
The extra cost of hiring an additional unit of labour or the marginal resource cost of labour (MRCL) is equal to the increase in the total cost of the firm resulting from hiring an additional unit of labour. That is
MRCL= ΔTC/ΔL
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