How do we separate substitution and output effects in factor demand after an input-price change?
Conditional demand holds output fixed for substitution; unconditional demand lets profit-maximizing output change.
Follow the cause and effect
Hold q fixed and minimize cost over K,L.
Use the cost function and output price to choose q.
Compare P×MP, MR×MP, and factor price to measure wedges.
The model you are using
Conditions for this model
Price-taking input and output markets, decreasing returns and no fixed cost in the numerical example.
The exam trap
Factor demand reflects more than substitution because higher cost can reduce output and all inputs.
Connect the reasoning to the graph
What changes
- Isoquant–isocost shows substitution at fixed q; the expansion path links least-cost points across q.
What stays fixed
Price-taking input and output markets, decreasing returns and no fixed cost in the numerical example.
Keep these conditions throughout the comparison; change only what the case above specifies.
What to inspect
Compare P×MP, MR×MP, and factor price to measure wedges.
Compare before and after, and locate the conclusion on the graph.
5 MINUTES · TRANSFER THE IDEA
Can you explain it without the lesson?
Explain how a wage increase affects K and L under conditional versus unconditional demand.