A firm produces chairs using labor and capital. The price of labor is \$50 dollar per unit, and the price of capital is $100 per unit. At current output, the marginal product of labor is 10 chairs, and the marginal product of capital is 15 chairs. To reduce the total cost of producing the current quantity of chairs, how should the firm change its spending on labor and capital?
Increase labor; Decrease capital. In order to reduce the total cost of producing the current quantity of chairs, one of the inputs to production must increase and the other must decrease. If neither changed, the cost would not be reduced. If one increased or decreased and the other did not change, the firm wouldn’t be producing the current quantity of chairs – it would be producing more or less, respectively. While the marginal product of labor (MPL = 10) is less than the marginal product of capital (MPK = 15), the RATIO of the MPL to the price of labor (10 / 50 = 0.2) is greater than the RATIO of the MPK to the price of capital (15 / 100 = 0.15). To reduce the total cost, the firm should increase spending on labor, which increases output by 0.2 chairs for every dollar spent, and decrease spending on capital, which only increases output by 0.15 chairs for every dollar spent.