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Suppose a firm’s production function is well-behaved and strictly convex. Additionally, suppose the firm is operating...

Suppose a firm’s production function is well-behaved and strictly convex. Additionally, suppose the firm is operating at some point where |T RS(L, K)| < pL/pK, where “|h|” indicates absolute value of some number h. Explain how this firm can increase its output without changing its total expenditure on inputs. Provide an additional argument for why a firm operating at a point where |T RS(L, K)| 6= pL/pK is not maximizing profit.

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Answer #1

We know RTS=MPL/MPK<PL/PK

Thus MPL/PL<MPK/PK which means firm should increase capital and should reduce labor in order to minimise cost without decreasing output

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