Question

4.1

Consider a profit-maximizing firm with the production function, q(L,K). Capital is fixed at K_0. Explain what happens to demand for L and to profits, p, under the following scenarios:
(a) w, the price of L rises
(b) v, the price of K rises
(c) p, the price of the output rises

Answer 1

Since capital level is fixed at K0, so it's a short run profit maximization,

Thus Labor demand will be a positive function of output price p & negative function of wage rate

As profit π = P* f(L,K) -w*L -v*K

Thus profit rises if , P rise, falls if input price rise.

A) w rises, profit falls, Labor demand falls

B) v rise, profit falls,

But as capital is fixed , so even it's rental price rise, can't lower its use, no effect on Labor demand

Also Profit falls .

C) Labor demand & profit both rise, as price of output increase.