Making dresses is a labor-intensive process. Indeed, theproduction function of a dressmaking firm is well described by theequation Q = L - L2/800, where Q denotes the number ofdresses per week and L is the number of labor hours per week. Thefirm's additional cost of hiring an extra hour of labor isabout $20 per hour (wage plus fringe benefits). The firm faces thefixed selling price P $40.
a. How much labor should the firm employ? What is its resultingoutput and profit?
b. Over the next two years, labor costs are expected to beunchanged, but dress prices are expected to increase to $50. Whateffect will this have on the firm's optimal output? Explain.Suppose instead that inflation is expected to increase thefirm's labor cost and output price by identical (percentage)amounts. What effect would this have on the firm'soutput?
c. Finally, suppose once again that MCL $20 and P $50 but thatlabor productivity (i.e., output per labor hour) is expected toincrease by 25 percent over the next five years. What effect wouldthis have on the firm's optimal output? Explain.