Question

Explain how to determine whether the law of demand holds given an input demand function and whether L and K are complements, substitutes, or unrelated inputs.

Answer 1

Demand is a desire for a good backed by willingness to pay and ability to pay. We know that there is a inverse relationship between demand and and price with other things being constant( Income, tastes, preferences). When the price of a particular good increases, its demand decreases. When price of a good decreases its demand increases and vice versa. It signifies that there is a negative relationship between demand and price.

Law of Demand:- Law of demand is one of the fundamental laws of micro economics.It works with the law of supply to explain how market economies allocate resources and determine the prices of goods and services that we observe in everyday transactions. The law of demand states that quantity purchased varies inversely with price. In other words, the higher the price, the lower the quantity demanded. This occurs because of diminishing marginal utility. That is, consumers use the first units of an economic good they purchase to serve their most urgent needs first, and use each additional unit of the good to serve successively lower valued ends. Economics involves the study of how people use limited means to satisfy unlimited wants. The law of demand focuses on those unlimited wants. Naturally, people prioritize more urgent wants and needs over less urgent ones in their economic behavior, and this carries over into how people choose among the limited means available to them. For any economic good, the first unit of that good that a consumer gets their hands on will tend to be put to use to satisfy the most urgent need the consumer has that that good can satisfy.

As we know that Labour and Capital (L&K) are the two important inputs in the production function. The labour and capital are not close substitutes of each other, but labour and capital are the complements of each other because In the short run, an increase in the wage leads to a decrease in the choice of labor. In the long run, capital can adjust, and since capital and labor are complements, the higher wage will lead to lower levels of both capital and labor.