1. Suppose there is a firm with two inputs of production, labor (L) and capital (K), with associated prices w and c, respectively. Also assume that the firm faces competitive input and product markets and that the two inputs are gross substitutes in production. Show graphically that long-run labor demand decreases as wages increase. What happens to the long-run demand for capital? Be sure to show the scale and substitution effects of a wage increase on the demands for labor and capital.
2. Describe and show graphically, using supply and demand curves, what the neo-classical view of labor markets implies should happen to employment in response to an increase in the federal minimum wage. What happens to the employment of low wage workers? What happens to the aggregate earnings of low wage workers if the elasticity of the labor demand curve is greater than one in absolute value?