Profit-Maximizing Behavior in Perfectly Competitive Factor Markets

Firms aim to produce a given level of output at the lowest possible cost by choosing the optimal combination of inputs, typically labor and capital.

Marginal Product per Dollar: To determine the most cost-effective mix of inputs, firms compare the additional output produced per dollar spent on each input:​

• Marginal Product of Labor (MPL) / Wage Rate (W)

• Marginal Product of Capital (MPK) / Rental Rate of Capital (R)

Cost Minimization Rule: Firms minimize costs when the marginal product per dollar is equalized across all inputs:​

• (MPL/W) = (MPK/R)

• This ensures that the last dollar spent on each input yields the same additional output.

Adjusting Input Mix: If the MP/dollar is higher for one input than another, the firm can reduce costs by using more of the input with the higher marginal product per dollar and less of the other