Question

Suppose a firm is currently minimizing costs in the long run with marginal product of labor and marginal product of capital given by K and L, respectively. If the price of capital falls by 50%, the capital-to-labor ratio will: A. increase by 50%. B. double. C. decrease by 50%. D. increase fivefold.

Answer 1

B. double.

Step-by-step explanation:

At the Pareto optimal point, MPK/MPL = Price of K/Price of L

Substitute the given information as :

L/K = r/w or K/L = w/r

When r decreases by 50%,

L'/K' = 0.5r/w or K'/L '= 2w/r

From above, K'/L' = 2(K/L)

Thus, capital to labor ratio (K/L) will double as double of capital will now be used since its price has fallen by half.