What is an example of the substitution effect?
A)Workers choose to provide more hours of labor when the wage rate decreases.
B)Hiring more labor as long as the marginal product of labor is positive.
C)The firm expands output when production costs fall.
D)The firm expands output when production costs increase.
E)The firm hires more labor when the wage falls because labor has become relatively cheaper compared to the price of other factors of production.

Question

Quizplus · Accepted Answer

The substitution effect is the change in the quantity of a good or service demanded due to a change in its relative price. In this case, a decrease in the wage rate makes labor relatively cheaper compared to other factors of production. Therefore, the firm will hire more labor, substituting it for the relatively more expensive factors of production. This is an example of the substitution effect.

What Is an Example of the Substitution Effect