Question

Show with isoquant analysis the effect on the cost minimized output for a firm that produces with inputs of capital and labor if (separate graphs) (3 points) a. A period of prolonged inflation raises the price level of all inputs in society (you can assume the firm will still spend the same amount of money) b. To take advantage of good economic situations, firms have increased their production budget.

Answer 1

In a period of prolonged inflation, the cost minimized output for a firm that produces with inputs of capital and labor is affected by the increase in input prices. When firms increase their production budget, the cost minimized output increases.

Step-by-step explanation:

In a period of prolonged inflation where the price level of all inputs in society increases, the cost minimized output for a firm that produces with inputs of capital and labor will be affected. The firm will try to conserve on using the more expensive input and will substitute it with other relatively less expensive inputs. This substitution can be shown on an isoquant analysis by a shift in the input combination needed to produce the same level of output.

When firms increase their production budget to take advantage of good economic situations, they may be able to afford more inputs, leading to an increase in the overall level of production. This can be shown by an outward shift of the production possibility frontier. As a result, the cost minimized output for the firm will increase.