An increase in the price of labour pivots the isocost line inward,
increasing its slope. This changes the cost-minimizing method of
producing any level of output. In part (i), the rise in the price of L from $1
to $4 per unit (with the price of K being held constant at $4) pivots the
$24 isocost line inward to the dashed line. Any output previously
produced for $24 will cost more at the new prices if it uses any labour.
The new cost of using the factor combination at A rises from $24 to $60.
In part (ii), the steeper isocost line is tangent to the isoquant at
not A, so that more capital and less labour is used. Costs at C are $48,
higher than they were before the price increase but not as high as they
would be if the factor substitution had not occurred.
Changes in relative factor prices will cause a partial replacement of factors that have become
relatively more expensive by factors that have become relatively cheaper.Of course, substitution of capital for labour cannot fully offset the effects
of a rise in the cost of labour, as Figure 8A-5(i) shows. Consider the
output attainable for $24. In the figure, there are two isocost lines
representing $24 of outlay—at the old and new prices of labour. The new
isocost line for $24 lies inside the old one (except where no labour is
Q= 6