A firm with production function q = K1/4L1/4pays $2.00 per unit for labour, $0.50 per unit for capital, has fixed costs of $50 and sells output at a price of $40. The price of labour falls to $0.50 per unit.

a.Provide a labelled Isoquant Diagram that decomposesthe input price change into substitution effect and output effect.

b.Prior to the reduction in the price of labour, profits are equal to _________ dollars.

c.We observe the firm using more capital even though capital is relatively expensive after the price of labour falls. John says that this happens because the substitution effect for labour dominates the output effect. Do you AGREE or DISAGREE (Circle)