Least Cost Rule
• When the last dollar spent
on each resource yields the
same marginal product
Least Cost Rule
• That is the cost of any
output is minimized when
the ratios of marginal
product to price of the last
units of resources used are
the same for each resource.
Least Cost Rule
MP of L =
Price of L
MP of C
Price of C
Profit Maximizing Rule
• Purely competitive resource
market the MRC = Price
• We know the profit maximizing
condition is MRP = MRC thus
• MRP = Price
Profit Maximizing Rule
• A firm will achieve its Profit
Maximizing combination of
resources when each resource is
employed at the point at which
MRP = Price
• PL = MRPL
PC = MRPC
Profit Maximizing Rule
MRPL
=
MRPC
=1
PL
PC
MRPs must be EQUAL to their
price and the ratio is therefore
equal to 1
Numerical Illustration
of Least Cost Rule
• Combination of Labor and Capital
in producing 50 units of output
• Trial and Error leads you to see 3
units of labor and 2 units of capital
• Total product 28+22 =50
Least Cost
• MP L = 6 = 3
C=9=3
P
8 4
12 4
Total Cost
(3 x $8) + (2 x $12) = $48
Check other combos for cost
All cost combinations are higher
Profit Maximizing
• Profit Maximizing is not at 50 units
• Profit Maximizing – each input
should be employed until it’s
Price = MRP
• If MRP > Price you can increase
profit by employing more of that
resource
Profit Maximizing
• Find where MRP = Price
• The firm should employ 5 units of
labor and 3 units of capital
• Total Cost
(5 x $8) = 40 + (3x $12) = 36 = $76
Profit Maximizing
Total Revenue = $130 find it two ways
• Total output (37+ 28) x $2 (price of key
chain)
• Sum of Total revenue of labor ($74) plus
Total revenue of capital ($56)
Profit Maximizing
• Total Revenue – Total
Cost = Profit
• $130 - $76 = $54