If the wage falls, we know for sure that the firm will produce more in the long run but we cannot be sure whether it will use more or less capital.

Question

Quizplus · Accepted Answer

When the wage falls, labour becomes cheaper and this makes it more attractive for firms to hire more workers. This would lead to an increase in production in the long run. However, whether the firm will use more or less capital is uncertain as it depends on the relative cost of labour and capital. If the fall in wage is significant enough, the firm may switch from using capital to using more labour, resulting in less use of capital. On the other hand, if labour still remains relatively expensive, the firm may choose to invest in more capital to substitute for the relatively expensive labour. Therefore, we cannot be sure whether the firm will use more or less capital when the wage falls.

If the Wage Falls, We Know for Sure That the Firm