If the price of labor increases relative to the price of capital,and as a result the quantity of capital hired decreases,the output effect of the price increase is greater than the substitution effect.

Question

Quizplus · Accepted Answer

When the price of labor increases relative to the price of capital, firms tend to substitute capital for labor. However, if the substitution effect is weaker than the output effect, then the overall impact on output will be negative. This is because the reduction in the quantity of capital hired will not be enough to offset the decrease in labor input, resulting in a decrease in overall output. Therefore, in this situation, the output effect of the price increase is greater than the substitution effect, leading to a decrease in output.

If the Price of Labor Increases Relative to the Price