1. From your textbook (Borjas. 3-4, read your textbook before solving for this question). Consider a firm for which production depends on two normal inputs, labor and capital, with prices w and r, respectively. Initially the firm faces market prices of w = 6 and r = 4. These prices then shift to w = 4 and r = 2.
(a) In which direction will the substitution effect change the firm's employment and capital stock?
(b) In which direction will the scale effect change the firm's employment and capital stock?
(c) Can we say conclusively whether the firm will use more or less labor? More or less capital?
2. (10 points) From your textbook (read your textbook before solving for this question). Suppose the hourly wage is $10 and the price of each unit of capital is $25. The price of output is constant at $50 per unit. The production function is f(E, K) = E 0.5K0.5 so that the marginal product of labor is MPL = (1/2)(K/E) (1/2)
(a) If the current capital stock is fixed at 1,600 units, how much labor should the firm employ in the short run?
(b) How much profit will the firm earn?