Question

In: Economics

Imagine a firm that only uses capital (K) and labor (L). Use an isocost / isoquant...

Imagine a firm that only uses capital (K) and labor (L). Use an isocost / isoquant diagram to illustrate the firm’s equilibrium input mix for given prices of capital and labor and a given rate of output. Now illustrate what happens if the price of labor falls, and the firm wants to produce the same rate of output. What happens to the cost of production? Compare the relative marginal products of labor and capital (the MRTS) at the two equilibria.

Solutions

Expert Solution

When price of labor falls, isocost line becomes flatter and now isocost line is AC. Equilibrium output will increase as price of labor falls. And equilibrium occurs at e1 level, where isocost line AC and isoquant line IQ1 are tangent with each other


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