A firm achieves least-cost in production by substituting factors until?

Answer Details

A firm achieves least-cost in production by substituting factors of production until the ratio of their marginal physical products equals the ratio of their prices. Marginal physical product (MPP) refers to the additional output produced by adding one unit of a factor of production while holding other factors constant. A firm can minimize its cost of production by substituting factors until the ratio of their marginal physical products equals the ratio of their prices. In other words, a firm should allocate its resources in a way that maximizes its productivity for every dollar spent. This means that the firm should use more of the cheaper factor and less of the expensive factor, as long as the marginal physical product of each factor is proportional to its price. For example, if labor is cheaper than capital, a firm should use more labor and less capital until the ratio of their marginal physical products equals the ratio of their prices. If the marginal physical product of labor is higher than the marginal physical product of capital, then the firm should use more labor and less capital to achieve the least-cost production. Therefore, a firm achieves least-cost in production by substituting factors until the ratio of their marginal physical products equals the ratio of their prices.