12 Suppose in a particular production process that capital a

12. Suppose in a particular production process that capital and labor are perfect substitutes so that three units of labor can always be substituted for one unit of capital. If the price of capital is $4 per unit and the price of labor is S1 per unit, the firm should employ only capital to minimize the cost of producing its output level. a. True b. False

Solution

It is given that labour and capital are perfect substitutes. It means the production of the good can be done by any one of labour or capital. It is also given that 3 units of labour can be substituted for 1 unit of capital. It means 3 units of labour can be used to produce an amount of good which can also be produced by 1 unit of capital. And it is given that price of labour is $1 and price of capital is $4. If the production is done with capital only, it costs much more as instead if labour would have been used it would be much less costly as labour and capital can be substituted at a ratio of 3:1. Thus the firm should employ only labour to minimise its cost of production.

False.