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What is the firms equivalent variation

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A firm uses two inputs, capital (K) and labor (L), in its production process. Capital and labor areperfect complements in production for this firm, meaning that they are only beneficial when employedtogether in specific proportions: specifically, they are effective when 1 unit of capital is paired with 1 unit oflabor, and any excess of one input (any units not paired with a unit of the other input) is wasted.

a) The firm has a budget of $900, the wage rate (price of a unit of labor) is $20, and the user costof capital (price of a unit of capital) is $10. How many units of capital and labor will the firm employ? Ifa government policy lowers the wage rate to $15, how many units of capital and labor will the firmemploy after the wage decrease?

b) What is the firm's compensating variation for the wage decrease described above? Doesthis amount represent a willingness to pay or a willingness to accept?

c) What is (the magnitude of) the firm's equivalent variation (EV) for the wage decreasedescribed above? Does this amount represent a willingness to pay or a willingness to accept?

Reference no: EM13213802

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