Assume that skilled labor and energy are substitutes in production. An increase in energy prices is then predicted to:

Question

Quizplus · Accepted Answer

An increase in energy prices will increase the cost of production, leading firms to substitute away from energy and towards skilled labor if possible. This is the substitution effect. However, if the increase in energy prices leads to a decrease in output (due to lower profits or higher prices for consumers), the demand for skilled labor may decrease as well due to a decrease in overall production. This is the output effect. If the output effect outweighs the substitution effect, then the demand for skilled labor will decrease. Therefore, the best choice is D.

Assume That Skilled Labor and Energy Are Substitutes in Production