Suppose capital and labor are used in fixed proportions so that each machine requires only one worker. If a decline in the price of capital occurs, then the demand for labor will
A)decrease solely because of the substitution effect.
B)increase solely because of the substitution effect.
C)increase solely because of the output effect.
D)decrease solely because of the output effect.

Question

Quizplus · Accepted Answer

When the price of capital decreases, firms are likely to invest in more capital since it becomes cheaper. Given that each machine requires one worker, as firms buy more machines, they will also need to hire more workers to operate these machines. This increase in demand for labor is due to the output effect, where the firm produces more output due to the lower cost of capital, thereby increasing its demand for labor to support the increased production.

Suppose Capital and Labor Are Used in Fixed Proportions So