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A firm is in the long run and is currently minimizing costs. The firm uses only...

A firm is in the long run and is currently minimizing costs. The firm uses only capital (K) and labor (L) in its production process. Minimum wage legislation is passed raising the minimum wage. Explain how the firm adjusts their inputs following the change. Be sure to explain each step thoroughly and explain when the firm reaches a new cost minimizing point.

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Answer #1

At cost minimizing, MPL/MPK = W/R. With an increase in Wage, the W/R ratio will increase. So to keep the situation at equilibrium, the ratio to the other side which is MPL/MPK have to increase. This is possible in two ways. By decreasing the number of labors the MPL will increase and the overall ratio will increase. Otherwise, by increasing the capital employed, the MPK will decrease and the overall ratio will increase, bringing the situation of equilibrium back. Now there will be cost minimization again.

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