No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Seven: Production: Man at Work 169 capital equipment, while others may be just the opposite. Profit maximization will require them to find out that precise combination of inputs that minimizes costs for a given output. If an entrepreneur is technologically and economically efficient, and produces at marginal revenue equaling marginal costs, he will maximize profits. If an entrepreneur is maximizing profit, he or she is satisfying consumer demand while using the least amount of scarce economic resources. That leaves more land, labor, capital, and entrepreneurship available to support other consumer desires. Profit maximization by an individual firm in a competitive market is therefore a necessary condition to maximize social welfare. When a firm is profit maximizing, they are not only directly serving us by producing a product we want to buy, but they are indirectly serving us by freeing up scarce resources which can be used to produce other goods we want to consume. THE WORKER IS WORTH HIS WAGE! How much should workers be paid? We discussed the intersection of supply and demand in chapter 5 to determine an equilibrium wage rate, and that is certainly an effective way to understand the market wage. But two concepts we’ve covered in this chapter will allow us to expand on how demand for labor is formed. How does an individual firm know how much it should be willing to pay an employee? We reviewed the marginal product of labor earlier, and found it to be equal to the additional output produced with the employment of an additional worker. So let’s go back to our SUBWAY restaurant competitor, Megan, who can produce an additional six sandwiches per hour with an additional worker, such that: MP L = 6 sandwiches / hr. Figure 7.11, Profit Max at MR=MC. In a purely competitive market, the marginal revenue simply equals the price. If an entrepreneur produces one more unit of output, he or she will be able to sell at the market price so the marginal revenue curve is a horizontal line. To maximize profit, the entrepreneur should expand output until the marginal cost curve exceeds the marginal revenue curve. Profit is maximized where marginal costs equal marginal revenues. Output Profit Maximization $ MC MR P Q * When a firm is profit maximizing, they are not only directly serving us by producing a product we want to buy, but they are indirectly serving us by freeing up scarce resources which can be used to produce other goods we want to consume.