Assume the price of capital falls relative to the price of labor and, as a result, the demand for labor increases. Therefore,
A)capital is very highly substitutable for labor.
B)the output effect is greater than the substitution effect.
C)the income effect is greater than the output effect.
D)the substitution effect is greater than the output effect.

Question

Quizplus · Accepted Answer

When the price of capital falls relative to the price of labor and the demand for labor increases, it indicates that the output effect (where firms produce more due to lower overall costs, thus requiring more labor) is greater than the substitution effect (where firms might substitute labor with cheaper capital). This leads to an overall increase in demand for labor despite the relative price change.

Assume the Price of Capital Falls Relative to the Price