The principle of substitution plays a central role in resource allocation because it demonstrates that
A)firms can use all factors of production interchangeably with no impact on their costs.
B)methods of producing the same commodity will not differ from one country to another.
C)prices will be relatively low for those factors for which demand is high relative to supply.
D)relative factor prices reflect relative scarcities of factors in the economy and so firms will find it profitable to make abundant use of relatively abundant factors.
E)firms will find it profitable to make abundant use of relatively scarce factors.

Question

Quizplus · Accepted Answer

The principle of substitution is based on the idea that when the price of one factor of production increases relative to others, firms will find it profitable to substitute the relatively cheaper factors for the expensive one. As a result, the relative factor prices reflect the relative scarcities of factors in the economy, and firms will make abundant use of relatively abundant factors. This principle plays a central role in resource allocation because it helps to explain how market forces determine the allocation of resources in the most efficient way.

The Principle of Substitution Plays a Central Role in Resource