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A pen maker uses labor and capital to produce their pens. They are both normal inputs...

A pen maker uses labor and capital to produce their pens. They are both normal inputs with prices w and r respectively. Initially workers were earning a wage of $10 per hour and capital was paying a rental rate of $8 per hour. If the input prices then changed to w=$7 and r=$6, what would be the substitution effect and scale effect? Would the firm employ more or less labor? more or less capital?

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Due to decrease in the wages, labour supply will be reduced. Because now labour would get less wages for the same hours of working. Substitution effect is from labour's point of view.

Scale effect is from producer's point of view. As wages are scaled down, so cost of production will be decreased. So more labour will be demanded. Hence, employment is scaled up.

Due to decrease in both wages and rent, then demand for both labor and capital will increase. So will employ more labour amd more capital.

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