Suppose the price of capital in the restaurant industry decr

Suppose the price of capital in the restaurant industry decreases. Explain how the decrease in the price of capital affects the demand for labor in this industry. Be sure to explain both the scale and substitution effects.

Solution

a decrease in the capital rate  increases the long-run demand for capital the increase in the demand for capital from a decrease in capital rates can be broken down into a substitution effect and a scale effect the substitution effect measures the effect of a change in an input price on the amount of inputs used to produce a given output level the pure substitution effect from a decrease in the capital rate ,to produce the same output level the profit-maximizing firm will use more capital and less labor a decrease in capital rates has a pure (output constant) substitution effect the scale effect measures the effect of a change in output levels (the scale of operation) on the amount of inputs used, holding input prices constant both the substitution and scale effects increase the quantity of capital demanded when the capital rate decreases;