Answer to Question #177504 in Microeconomics for Saad

Question

The Market System and The Circular Flow

Assume that a business firm finds that its profit is greatest when it produces $40 worth of product A. Suppose also that each of the three techniques shown in the following table will produce the desired output.

Resource

Price per unit ($)

Technique 1Units

Technique 2Units

Technique 3Units

Labor

3

5

2

3

Land

4

2

4

2

Capital

2

2

4

5

Entrepreneurial Ability

2

4

2

4

a) With the resource prices shown, which technique will the firm choose? Why? Will production using that technique entail profit or loss? What will be the amount of that profit or loss? Will the industry expand or contract? When will that expansion or contraction end?

b) Assume now that a new technique, technique 4, is developed. It combines 2 units of labor, 2 of land, 6 of capital, and 3 of entrepreneurial ability. In view of the resource prices in the table, will the firm adopt the new technique? Explain your answer.

Answer 1

a) With the resource prices shown, the firm will choose technique 2, because its total cost is 34 compared to 35 for techniques 1 and 3.

The production using that technique will entail profit of TP = 40 - 34 = 6.

The industry will expand.

That expansion will end when profit becomes zero.

b) If technique 4 is developed, which combines 2 units of labor, 2 of land, 6 of capital, and 3 of entrepreneurial ability, then in view of the resource prices in the table, the firm will adopt the new technique, because the total cost will be 32.