A firm is set up to produce and sell cotton shirts. It buys plant and machinery for $2 million and land for $1 million, and constructs a warehouse for another $1 million. Each year, it hires 100 workers and pays each of them $2,000 per year. It buys $600,000 worth of cotton fabric to be used in making the shirts. The firm sells 100,000 shirts a year, which it prices at $10 per shirt.

(a) How much profit does the firm make on a yearly basis, if you do not count its setup investment?

(b) How much income does the firm generate every year?

(c) What is the capital–output ratio of the firm? Explain, using this example, why a capital–output ratio that exceeds 1 is perfectly compatible with profit making.