a) What are the two main assumptions underlying the “neoclassical” theory of a short-run labor demand curve that is declining in rising wage rates (i.e., the “Law of Demand”)?
b) Suppose there is a firm with two inputs of production, labor (L) and capital (K), with associated prices w and r, respectively. Also assume that the firm faces competitive input and product markets and that the two inputs are gross complements in production. Show graphically the long-run labor demand as the wage increases. What happens to 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.