Least Cost Rule and

Profit Maximizing Rule

Getting the Most Bang for Your Buck as a ProducerPacket o’graphs page 32

Least Cost Rule

� Remember the prime directive of the seller: firms want to use the combination of resources in production to maximize profits

� Least Cost Rule: Sellers maximize utility just like consumers when they purchase things

� MP LABOR = MP CAPITAL$ LABOR $ CAPITAL

� Long run cost curves assume that each level of output is being produced with the least cost combinations of inputs

Profit Maximizing Rule

� Profit maximizing rule states that in a competitive market, the price of the resource must equal marginal revenue product (MRP)

� MRP LABOR = MRP CAPITAL

$ LABOR $ CAPITAL = 1

MRP vs. MP

� MRP = ∆ Total Revenue

∆ inputs

� or MRP = Marginal Product (or Marginal Physical Product ) x Price of product - perfect competition only!

� MP = ∆ total product

∆ inputs

In Any Event, Know the

Two Formulas

With your working group, write out

your own answers – Ch. 27, #4

Capital MP Capital Labor MP Labor

0 0

1 1

2 2

3 3

4 4

5 5

6 6

7 7

8 8

242118159631

11987641

1/2

Use the information from the chart. In a perfectly competitive market, capital costs $3 per unit and labor costs $1 per unit. Product price is $1.

a) What is the least cost combination of labor and capital the firm should use for producing 80 units of output?

b) What is the profit-maximizing combination of labor and capital? What is the level of output? What is the economic profit? Is this the least costly way to produce the profit maximizing output? (product price is $1)