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Suppose that there is a decline in the cost of a unit of capital, in the long run. 

a. What will be the substitution effect of this change on use of capital and labor, and why? How would this be shown on an isoquant diagram? 

b. What will be the scale effect of this change on use of capital and labor and why? How would this be shown on an isoquant diagram? 

c. What will be the net or total effect of this decline in the cost of capital on the use of capital and labor?

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Anne Gillian Duero
Anne Gillian DueroLv10
28 Sep 2019

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Related questions

Consider a firm for which production depends on two normal inputs, labor and capital, that are not perfect complements. Initially the firm faces market prices of w = 10 and r = 8, for labor and capital. These prices then shift to
w = 7 and r = 7.

a) In which direction will the substitution effect change the firm's employment and capital stock?

b) In which direction will the scale effect change the firm's employment and capital stock?

c) Can we say conclusively whether the firm will use more or less labor? More or less capital?

Consider a firm for which production depends on two normal inputs, labor, and capital, that are not perfect complements. Initially, the firm faces market prices of w = 10 and r = 8, for labor and capital. These prices then shift to w=7 andr=7.

a) In which direction will the substitution effect change the firm's employment and capital stock?

b) In which direction will the scale effect change the firm's employment and capital stock?
c) Can we say conclusively whether the firm will use more or less labor? More or less capital?

2) The wage for workers in a competitive economy 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) 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?

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