This problem illustrates the substitution effect. The widget industry can produce one widget with one of two technologies. Technology A uses three units of labor and four units of capital while Technology B uses four units of labor and three units of capital.

a. If wages are $3 per worker and capital cost is $2 per unit of capital, which technology will the widget industry use?

How many workers per unit of output will the industry employ?

b. If wages are $2 and capital cost is $3 per unit, which technology will the widget industry use?

How many workers per unit of output will the industry employ?

c. What is the substitution effect?