As a response to a change in the wage rate, the substitution effect will:
A)produce an direct relationship between the quantity demanded of an input and its price.
B)produce an direct relationship between the quantity demanded of an input and the price of the other input.
C)produce an inverse relationship between the quantity demanded of an input and the price of the other input.
D)produce an inverse relationship between the quantity demanded of an input and its price.

Question

Quizplus · Accepted Answer

The substitution effect refers to the change in the quantity demanded of a factor of production in response to a change in its wage rate, holding all other factors constant. When the wage rate for a factor of production increases, firms will substitute away from it and towards other factors that are relatively cheaper. This will lead to a decrease in the quantity demanded of the more expensive factor and an increase in the quantity demanded of the relatively cheaper factor. Therefore, the substitution effect will produce an inverse relationship between the quantity demanded of an input and its price.

As a Response to a Change in the Wage Rate