If the price of labor falls relative to the price of capital,and as a result the quantity of capital employed decreases,it can be concluded that:
A) the substitution effect is greater than the output effect.
B) the output effect is greater than the substitution effect.
C) the income effect is greater than the output effect.
D) labor cannot be easily substituted for capital.

Question

Quizplus · Accepted Answer

The substitution effect is the tendency for producers to substitute a cheaper input for a more expensive input. The output effect is the tendency for producers to increase output when the price of an input falls. In this case, the price of labor has fallen relative to the price of capital, so the substitution effect is greater than the output effect.

If the Price of Labor Falls Relative to the Price