Question for Thought 1 Referring to the output and substitut

Question for Thought 1. Referring to the output and substitution effects, explain why an increase in the wage rate for autoworkers will generate more of a negative employment response in the long run than in the short run. Assume there is no productivity increase and no change in the price of nonlabor resources. SHOT ON MI 6 MI DUAL CAMERA

Solution

In the short run, while maximizing its profits firms would want to produce a specific units of output while the capital is fixed. Hence, the firms won\'t be able to substitute capital in place of labor. Even at a higher wage rate, it will continue to hire more workers in the short run because it cannot change the capital in the production process.
This may not be the case in the long run when the firm can replace the labor either with capital (e.g. - automation). Also, in the long run the firm is able to makes changes in its optimal capital-labor ratio depending on the relative wage-interest rate ratio.