Answer to Question #88674 in Economics for Sabreen Rehana Nisha

Question

Consider a firm for which production depends on two normal inputs, labour and capital, with prices w and r, respectively. Initially the firm faces market prices of w = 6 and r = 4. The price of capital (r) then shifts to r = 6 while w remains the same. Use isocost-isoquant analysis to show and explain the following.
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 labour and more or less capital?

Answer 1

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