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Suppose a firm finds that the marginal product of capital is 60 and the marginal product of labor is 20. If the price of capital is $6 and the price of labor is $2.50, how should the firm adjust its mix of capital and labor? What will be the result?

If a firm finds that the marginal product of capital is 60 and the marginal product of labor is 20, it will recognize that each dollar spent on capital will outproduce a dollar spent on labor. The marginal benefit of capital is 10 versus 8 for labor. $1 spent on capital will yield 25% more than $1 spent on labor until the firm begins to experience diminishing returns on capital.

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If a firm finds that the marginal product of capital is 60 and the marginal product of labor is 20, it will recognize that each dollar spent on capital resources will produce more than a dollar spent on labor resources.

With the price of capital at $6, the marginal benefit of capital is 60 divided by $6, or 10. The price of labor is $2.50, and the marginal product of labor is 20, as noted. Therefore, the marginal benefit of capital is 20 divided by $2.5, or eight. Each additional dollar spent on capital versus on labor will yield 25% more product. This indicates that the firm should deploy its additional funds more aggressively into expanding capital resources than labor resources until it begins to experience diminishing returns on capital.

According to the law of diminishing returns, the incremental return of increasing an element of production will eventually fall. At some point in the future, the marginal product of capital will decline from 10 units, and it will no longer make sense...

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