The Acme bag company manufactures and sells bags using paper and labor. Currently workers are paid $6 per hour and paper costs $20 per ton. Acme’s current total costs of production are $200,000 per day.
a. Write an equation for, and illustrate on a graph the isocost line for Acme. Label each intercept and note the slope of the isocost line.
b. Assuming Acme has curved, convex isoquants, illustrate their likely response to an increase in the wage. Clearly show the amount of labor and paper used before and after the wage increase.
c. It is easy to imagine that labor and paper must be used in a fixed proportion to produce paper bags. What does this suggest about the elasticity of substitution of paper for labor in Acme’s technology? Draw an isocost and isoquant diagram that represents this technology. Show what happens in this case in response to a wage increase. Briefly explain how this is different than the case in part b.