Question

2. Changes in the price of labor will result in both substitution and scale effects that determine what will happen to a firm’s employment of both capital and labor in the long run. Give an example of a production process where you think the substitution effect will most likely dominate the scale effect. In addition, give an example of a production process where you think the scale effect will most likely dominate the substitution effect. Explain your reasoning clearly.

Please give real-life examples that I can use to answer this question

Answer 1

Suppose the price of labor was $50 per hour. There is 24 hours in day. So at $50 per labor woks for 8 hours in a day and they spend 16 hours of leisure time. If price of labor is increased to $70 per hour.  
Substitution effect dominates the scale effect
Substtitution effect occurs if wage rate of labor increased, then labor will be willing to work more and substitute away their leisure time. Because opportunity cost of leisure time rises at higher wage rate.
In this case, ( substitution effect dominates scale effect) as wage rate increased from $50 to $70, labor will increase his worling hours to 11 hours. It will reduce their leisure time to 13 hours. In this case firm will employ more labor and less capital, because even though the price of labor rises, they increased their labor hours and it will increase the labor productivity
Scale effect (income effect) dominates the substitution effect.
Suppose if wage rate increase, labor will reduce his working hours and so they can spend their higher income on leisure time.
If wage rate again increased to $90. Here income effect or scale effect dominates the substitution effect. At this wage labor will reduce the workih hours to 9 hours and increase the leisure time to 15 hours. At this time firm will employ more capital and less labor. Because even at higher wages labors are not willing to work for more hours, instead they reduce their working hours. So they can cheaply use the capital for production purposes