Suppose a firm is using a production technology where capital and labour are imperfect substitutes. Suppose the market is perfectly competitive.

1. Suppose a firm is using a production technology where capital and labour are imperfect substitutes. Suppose the market is perfectly competitive.

(a) (4 points) Create a graph displaying the isoquant and isocost for the firm in the short run (assume the firm does not have the ideal long run combination of capital to labour). Let capital be the fixed factor of production K¯ . Furthermore suppose capital is twice as expensive as labour. Make sure to label all important curves, points, and axes.

(b) (4 points) Suppose the cost of labour increases due to government increasing the minimum wage, now the cost of capital and labour are the same. How does this influence production and the isocost?

(c) (3 points) If the firm is able to reallocate both capital and labour, how does this effect the isoquants and isocosts? Illustrate this change using dashed lines in the graph from part (a).

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