Consider a firm for which production depends on two normal inputs, labor and capital, with prices w and r, respectively. Initially the firm faces market prices of w = 6 and r = 4. These prices then shift to w = 4 and r = 2.
(a) In which direction will the substitution effect change the firm's employment and capital stock?
(b) In which direction will the scale effect change the firm's employment and capital stock?
(c) Can we say conclusively whether the firm will use more or less labor? More or less capital?