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IAI Actuarial Core Principles · Business Economics · Main economic schools and their key features

In neoclassical theory, a profit-maximising competitive firm hires labour at a wage of Rs 600 per day. The marginal physical product of the last worker is 4 units and the output price is Rs 140. The firm is considering whether to change employment. Which conclusion follows from marginal productivity theory?

The firm should hire fewer workers. The last worker's marginal revenue product is 4 x Rs 140 = Rs 560, which is less than the Rs 600 wage, so cutting employment raises profit until MRP rises to equal the wage.

  1. AHire fewer workers, because the marginal revenue product of Rs 560 is below the wageCorrect
  2. BHire more workers, because the marginal revenue product of Rs 560 exceeds the wage
  3. CKeep employment unchanged, because the marginal revenue product equals the wage
  4. DHire more workers, because the marginal revenue product of Rs 144 exceeds the wage
  5. Hire fewer workers, because the marginal physical product is below the wage

Explanation

Marginal revenue product = MPP x price = 4 x 140 = Rs 560. This is below the wage of Rs 600, so the last worker adds less to revenue than to cost. The firm should reduce employment until MRP equals the wage. Hiring more would widen the loss on the marginal worker.

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