The Cheesecake Palace uses two inputs to produce cheesecakes: ovens (K) and workers (L). The ovens cost $800 per day to operate; and the workers earn $200 per day. At the current level of production, the marginal product of the last oven is an additional 200 cheesecakes per day, and the marginal product of the last baker hired is 50 additional cheesecakes per day.
Question A (10 points)
The corporate office has determined that the own-wage elasticity for bakers is estimated to be EL = -0.24. Management has decided to decrease wages of bakers by 10%, what is the size of the expected effect on the number of bakers employed?
Question B (5 points)
Given your answer to Question A, is it possible to determine which effect (scale or substitute) is stronger? If yes, which effect is stronger?
Question C (10 points)
The corporate office has also determined that the cross-wage elasticity for ovens (based on the wages of bakers) is EK, L = -0.30. What effect will the given wage change (from Question A) have on the amount of ovens used?
Question D (5 points)
Given your answer to Question C, is it possible to determine which effect (scale or substitute) is stronger? If yes, which effect is stronger?
Question E (2 points)
Given the information above, is this firm optimizing their production given the current use of inputs? Why? (Discuss the sufficient conditions for optimal production.)
Question F (3 points)
Given the information presented above and your answer to Question E, should the firm change their mix of inputs? If yes, how should they change the amount of capital or labor they currently use?
