Chapter 7: Problem 25

In choosing a production technology, how will firms react if one input becomes relatively more expensive?

Short Answer

Expert verified

In conclusion, a firm reacts to an increase in the relative price of an input by considering substitution possibilities, analyzing the impact on output, and adjusting production technology or processes to maintain cost effectiveness and competitiveness. This may involve using more capital-intensive production methods, such as automation, to reduce the use of the more expensive input.

Step by step solution

Identify the inputs and production technology

First, let's identify the inputs and the production technology. Inputs are the resources used by a firm in the production process, such as labor, capital, and raw materials. Production technology represents the way a firm combines these inputs to produce output. Firms choose their production technology based on efficiency and cost effectiveness.

Understand the concept of relative price

Relative price refers to the price of one input compared to the price of another input. When the relative price of an input increases, it means that the cost of using that input in the production process has become more expensive compared to other inputs. Firms will react to this change by considering alternatives or adjusting their production process.

Analyze the substitution possibilities

When the relative price of an input increases, firms will assess whether they can substitute other inputs in the production process to minimize costs. For example, if the price of labor increases relative to the price of capital, a firm may consider using more capital-intensive production methods, such as automation, to reduce the use of labor.

Analyze the effect on output

Firms will also analyze how the change in input prices will affect their output levels. If the output is unaffected by the substitution of a more expensive input, the firm may continue with the current production technology. However, if the substitution reduces the output level and affects the firm's competitiveness in the market, they may need to adjust their production technology or processes further.

Determine the firm's reaction to the relative price change

Based on steps 3 and 4, a firm will react to an increase in the relative price of an input by: 1. Assessing the possibility of substituting the more expensive input with a less expensive alternative. 2. Analyzing the effect of the substitution on the output level and competitiveness in the market. 3. Adjusting production technology or processes accordingly to minimize costs and maintain or improve output levels. In conclusion, a firm will react to an increase in the relative price of an input by considering substitution possibilities, analyzing the impact on output, and adjusting production technology or processes to maintain cost effectiveness and competitiveness.