Question

question5

R O 5A. TF: Ifthe marginal rate of technical substitution of labor for capital (MRTSLK) exceeds the relative price of labor in terms of capital (P/PK), then the firm needs to use less capital and more labor to reach its expansion path. Clearly demonstrate and relate your answer to a Graph. f you relate this back to indifference curves and budget constraints this is really an easy question. Present short answer during class presentation. GROUP 5 5B. Consider the following: uppose the government imposes new regulations that force tire manufacturers to incur some one-time expenses for factory safety improvements. Will the new regulations raise the price of tires? Will it reduce the quantity of tires each firm produces? Explain! ii. Suppose the government imposes new regulations that force tire manufacturers to adopt cleaner production methods that raise the production cost by $10 per tire. Will the new regulations raise the price of tires? Will it reduce the quantity of tires each firm produces? Carefully Explain why or why not! Class Presentation

Answer 1

i) Regulations are generally imposed to control the amount of output produced by the firm or to give the firms incentive to decrease their output. Regulations are imposed on the tire manufacturers which is a one-time expense, Say, the amount of the expense be T. This can be treated as an external shock incurred by the firm. This will decrease the firm's profit by amount T for that specific period only. This cost will not affect the production cost of future productions. This can be treated as a fixed cost. Since it will not affect future production costs, this extra cost will not increase the price of tires. The market demand will not be affected due to regulation. Since the demand remains the same as before, each firm will produce the same quantity of tires as before. There will be no reduction in quantity.

ii) Now, the government introduces a regulation that increases the production cost of the tire by $10. So, each tire now costs $10 extra to produce. This affects the production decision of the firm directly. The production cost of the firm increases and profit decreases. So, the firms will increase the price of the tires to pass some of the burdens of the regulation to the buyers. So, the price of the tire will increase. If the market demand decreases due to the higher price of the tires, then each firm will produce a lower quantity of tires. If the market demand remains unaffected, then each firm will continue producing the same quantity.