Question: This problem will show why firms are more efficient in the long run than in the short run. Assume that the United Megabucks Corporation can produce running shoes using labor and capital. We know that the company wants to produce 1,000 shoes per hour.

a) Draw United Megabucks’ (normal-looking) isoquant. Add some isocost lines and label the best possible combination of labor and capital “e”.

b) Assume that United Megabucks’ workers receive a big wage increase.

i) Show what the wage increase does to your isocost line.

ii) Show what happens to the best possible combination of capital and labor in the long run. What happens to the cost of production?

iii) Show what happens to the best possible combination of capital and labor in the short run. What happens to the cost of production?

iv) Do costs increase more in (ii) or (iii)? Why?