Question

Isoquant: Q = 70 Tangency Isocost: TC = $? Figure 1. Isoquant and Isocost Price of L - $20; Price of K = ? : TC = ? 14. Refer to Figure 1. The intercept of the isocost on Kaxis is 10 15 20 33.33

Answer 1

Let P_K be the price of capital and P_L be the price of labour.

P_K = ?, P_L = $20

14) Along the iso-cost line, total cost of employing labour and capital is same. Therefore cost of employing 10L & 0K is same as cost of employing 6L & 8K

Cost of 10L & 0K = 10 P_L + 0 P_K = 10 (20) + 0 (P_K) = 200 +0 = 200   ……(i)

Cost of 6L & 8 K = 6 (20) + 8 (P_K) = 120 + 8 P_K …..(ii)

Equating (i) and (ii) we get,

200 = 120 + 8 P_K

Hence, P_K = (200 – 120)/ 8 = 80/8 = 10

Ans: Intercept of K axis = total cost on iso-cost line/ P_K = 200/10 = 20

15) at the equilibrium point or where cost of producing 70 units of output is minimised,

MP_L/MP_K = P_L/P_K

Marginal productivity of labour = MP_L

Marginal Productivity of Capital =MP_K

P_L= $20, P_{K =} $10

Hence MP_L/MP_K = 20/10 = 2

Therefore MP_K/MP_L = ½

Ans: Relative productivity of capital to labour i.e. MP_K/MP_Lis ½

16) If the price of capital increases, less of capital can be employed,

If the total cost remains same then, the iso-cost line will rotate inwards on the K axis while the labour intercept will remain same as price of labour is still the same. This means, output Q = 70 can no longer be produced.

Note as iso cost line has moved inward, Q =70 cannot be produced by altering amount of labour input. Output Q = 70 is possible only if total cost is increased.

Ans: It is no longer possible to produce Q = 70 with the original total cost.

17) MP_K/MP_L = P_K/P_L

Hence if productivity of capital relative to labour is declining, means either P_K is declining relative to P_L or P_L is increasing relative to P_K

Let us understand each of the options

We will choose the option that leads to either increase in price of labour or decrease in price of capital.

Country’s general savings rate drops means interest rate increases or price of capital increases. So this option is not acceptable

Pay-roll tax rate drops so that firm’s actual labour cost decreases means price of labour decreases. This option is also not acceptable

More rigorous immigration regulations implemented will lead to less labour supply thereby increasing the price of labour. This option is acceptable as price of capital relative to labour will decline leading to decline in productivity of capital relative to labour

The Federal Reserve Bank increases the rate of interest leads to increase in price of capital. Hence this option too is not acceptable.

Ans: A right-wing political party wins the election and more rigorous immigration regulations are implemented