Jon runs a bar in New York City. A city law prevents smoking in New York bars, but Jon is able to convince a friend in city hall to grant his bar a smoking permit by exploiting some fancy loopholes in the law
While smoking enables Jon to charge a premium to the customers (higher drink prices), his workers are subject to second-hand smoke. Therefore Jon has to pay his workers a wage higher than he otherwise would. Assuming Jon's production function is f(L,K) = L?K1-?, where L is the quantity of workers and K is the quantity of capital, how does Jon's optimal capital-to-labor ratio compare to similar bars without smoking?
Jon will employ more capital and less labor as
MRTS = ?K/?L = w/r
An increase in w (from overcoming the disutility of second-hand smoke) will mean the ratio of K/L must increase.
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