Consider a fall in the wage rate. How does the substitution effect change the amount of labor that a firm hires? How does the scale effect change the amount of labor that a firm hires? What do these effects imply about the firm's long-run demand for labor?
What will be an ideal response?
When the wage rate falls, the expansion path shifts down. Firms will use more labor and less capital to produce any given level of output, and this substitution effect increases the firm's long-run use of labor. If labor is not a regressive factor, the lower wage also lowers the firm's long-run marginal cost. The firm responds by increasing its output level and hiring still more labor-this is the scale effect. In this case, both the substitution and scale effects support the law of demand, so the firm's long-run demand curve for labor is downward sloping. If labor is a regressive factor, then the lower wage increases the firm's marginal cost and lowers its output. Thus, the scale effect is in opposition to the substitution effect. The law of demand will still hold when labor is regressive, however, because the scale effect cannot outweigh the substitution effect in this case.
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