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150a_hw2_key - Economics 150A Labor Economics Assignment 2...

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Economics 150A Labor Economics Assignment 2 Spring 2011 1. Graphically show the long-run demand for labor if the price of capital increases. To determine how an increase in the price of capital changes the demand for labor, suppose initially that the firm is producing 200 units of output at point P in figure 2. The increase in the price of capital (assuming capital is a normal input) increases the marginal costs of the firm and will reduce the profit-maximizing level of output to say 100 units see figure 1. The increase in the price of capital also flattens the isocost curve, moving the firm to point R. The move from point P to point Q can be decomposed into a scale effect which reduces the demand for capital, and decreases the demand for labor. The substitution effect (Q to R) reduces the demand for capital and increases the demand for labor. The direction of the shift in the demand curve for labor, therefore, will depend on which effect is stronger: the scale effect or the substitution effect. The effect on labor is ambiguous. The effect on capital is not ambiguous; it decreases. 100 200 MC 0 P MC 1 Dollars Output Figure 1 100 200 R P Q Capital Employment Figure 2 Figure 2 shows employment increases. You should have a 2nd graph showing employment decreases. If this were a test question, you would be expected to show all graphs as the directions ask. 1
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2. A firm uses 1 capital for every 8 workers to produce 1 output. The price of output is $75, the wage rate is $6, and the rental rate for capital is $2 per unit. Assume capital is not a fixed cost.
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