The wage for workers in a competitive wages is initially $6 and rent, the cost o
ID: 1219164 • Letter: T
Question
The wage for workers in a competitive wages is initially $6 and rent, the cost of capital (also rented in a competitive market), is initially $8. Now suppose that wages increase to $8 and rents increase to $12.
a) Describe how the scale effect changes a firm's use of labor and capital.
b) Describe how the substitution effect changes a firm's use of labor and capital. c)
c) Overall will a firm hire more or fewer workers? Will a firm rent more or less capital?
d) Will a firm change its production technology given the changes in w and r?
Explanation / Answer
a. when the costs of both input factors increase, it shows direct impact on product cost. i.e. the cost of product will be increased in the same proprotion to the producer. the avialiability of labor will increase in the market, similarly capital availability also increases. but the use of both factors will decreased by the firm, to minimise the total cost, they will use in an optimum combination of these both inputs.
2. if both these are perfect substitutes, then the proportion of labor will increase than the proportion of capital. i.e. more labor is used by replacing capital, it can be possible upto minimzation of total cost of product.
3. a firm go with more workers and less capital. becaue the increased cost of labor is higher than increased cost of labor and both are perfect substitutes.
4. yes, this firm now becomes laboristic firm, where majority of the works completes with people only.
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