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isoquant/isocost diagram

Use an isoquant/isocost diagram and words to show how firms will respond to a decrease in the wage rate. Be sure to identify the short run scale effect and the long run substitution effect.

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? given a wage rate W1 the firm maximizes profits at point B
o in the upper diagram, the GH isocost line (with slope W1/r) is tangent to the Qb isoquant at point B
 the firm uses Lb units of labor and Kb units of capital to produce Qb units of output
o in the lower diagram, in the long run the firm hires LB unit of labor when the wage rate is W1; point B is one point on the demand for labor
? now suppose that the wage rate decreases to W0
o the GH isocost line will rotate outwards to the line GF (the horizontal intercept COST/W0 is now located farther from the origin) and the new set of isocost lines will be with slope W0/r.
o a decrease in the wage rate also shifts firms' ...

Solution Summary

An isoquant/isocost diagram is depicted.

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