Can someone please explain this concept to me in greater detail. It is about the optimum combination of factors in the long run and is explained in chapter 9 page 186... I just wanted to know of a different way of explaining it. Any suggestions would be great! Thanks!
Try just considering a situation with just two factors of production: labour (L) and capital (K). Imagine that: - employing one more unit of labour costs 10, and that this increases output by 50 (ie P(L)=10 and MPP(L)=50 - employing one more unit of capital costs 5, and that this also increases output by 50 (ie P(K)=5 and MPP(K)=50). It is clearly more cost efficient to increase output by employing one more unit of capital than one more unit of labour (as you only pay 5 and output increases by 50). So you keep adding more units of capital while this is more efficient. Eventually, capital will get more expensive as economies of scale set in, and so at some point we might get to the stage where: - employing one more unit of capital costs 10, and this increases output by 50. When this happens, we can’t increase efficiency by changing the relative amount of labour to capital, so the cost minimising output occurs when the ratios of MPP to price are equal. Does this help?
