Land in the Shire can be used for growing carrots or potatoes,
and the only variable input into production is labor (land is
fixed). All workers are paid the same wage. There are two
farmers: Sam grows carrots, and the marginal product of labor
on his farm is 30 pounds of carrots per month. Merry grows
potatoes, and the marginal product of labor on his farm is 44
pounds of potatoes per month. Each experiences diminishing
returns to labor. The price of carrots is $3 per pound, and the
price of potatoes is $2 per pound.
a. Calculate the value of the marginal product of labor in
carrots and in potatoes to assess whether the economy of
the Shire is efficient in output levels. Is the economy in
general equilibrium?
b. Do the prices of carrots and potatoes signal that farmers
should produce more or less of their crops? In which
direction will employment levels adjust in response to the
market prices for the two crops? Describe how the economy reaches general equilibrium.