Concepts
- Cost Minimizing Input Combination
- Marginal Product
- Marginal Product per Dollar Spent on Labor (MPL/PL)
- Marginal Product per Dollar Spent on Capital (MPK/PK)
- MPL/PL = MPK/PK
- Productive Efficiency
- Producing at the Minimum Point on the ATC (MC = ATC)
- Occurs When Employing the Cost Minimizing Input Combination
Overview
Just like people trying to get the most out of their budget, businesses want to get the most out of their money spent on production. This happens by producing at the cost minimizing combination of inputs. To fully grasp this concept students must understand the meaning of marginal product. Marginal product (MP) is the additional production from hiring one more worker (MPL) or renting one more machine (MPK). It’d be nice if we could just compare the MP of each input to see which gives us the most “bang for our buck,” but unfortunately, the price of each input usually differs so we can’t just compare the MPs. To make these measurements comparable, we need to take the MP of each input, then divide out the P of each input. This gets the additional production down to a per dollar basis (bang for your buck) which allows us to compare each measurement accurately. Once the MP per dollar spent on each input is equal, we know for a fact that we’ve reached Cost Minimization. We can’t get any more efficient from buying more of one/less of the other. If however, the MP per dollar spent on labor (MPL) is greater than the MP per dollar spent on capital (MPK), then we can get more efficient by renting less machines and hiring more workers. Productive efficiency occurs when a firm operates at the minimum point of the average total cost curve (ATC). It’s a by-product of employing the cost minimizing combination of inputs. Productive efficiency also occurs when the MC=ATC. This happens because ATC always intersects MC at the minimum of ATC.
Materials
Lecture
Cost Minimization and Productive Efficiency Lecture Video
Quiz
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