Question

Suppose our firm produces chartered business flights with capital (planes) and labor (pilots) in fixed proportion (i.e. one pilot for each plane). If the wage rate paid to the pilots increases relative to the rental rate of capital for the airplanes, then? Please explain your answer.

A. Optimal capital labor ratio should increase.

B. Optimal capital labor ratio should decrease.

C. optimal capital labor ratio remains the same

D. Not enough information to answer question

Answer 1

C. optimal capital labor ratio remains the same

One pilot for each plane implies L = K
Let cost be C
So, isocost line is wL + rK = C
So, wL + rL = C (as L = K)
So, (w+r)L = C
So, L = C/(w+r) = K

Optimal capital labor ratio = K/L = 1 as K = L

Now, wage rate increases to w'
So, isocost line is w'L + rK = C
So, w'L + rL = C (as L = K)
So, (w'+r)L = C
So, L = C/(w'+r) = K

New optimal capital labor ratio = K/L = 1 as K = L
Thus, optimal capital labor ratio remains same because capital (planes) and labor (pilots) are used in fixed proportion.