Final answer:
This question explores cost pools in production decisions, showing that increases in labor costs may lead businesses to favor more capital-intensive methods. Companies weigh the trade-offs between labor and machinery, often aided by economies of scale that lower average costs as production scale increases.
Step-by-step explanation:
The question pertains to the concept of cost pools and decision-making in production based on labor costs and equipment costs. It shows how firms may adjust their production methods in response to changes in labor costs due to union negotiations. When labor costs increase, firms might opt for more capital-intensive production methods, which involve higher usage of machinery and less labor. Such a decision involves calculating various costs to determine which combination of labor and machines results in the lowest total cost of production.
For example, a firm producing a home exercise cycle might find that with labor costs at $16 an hour (including benefits) and machine costs at $200 each, the optimal production plan might be 50 hours of labor and one machine. However, if labor costs rise to $20 an hour due to union negotiations, the firm could be indifferent between using more labor and fewer machines or vice versa. The ultimate decision may tilt toward using more machines due to factors like labor strikes avoidance, despite machines not contributing to market demand as consumers.
In the broader context of production costs, firms experience economies of scale when increasing the scale of production leads to lower average costs. A small factory might produce goods at a higher average cost compared to a larger factory that benefits from economies of scale and produces at a lower average cost.