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Denote the firm's optimal factor demand by k(p, w, r) and (p, w, r). Suppose that capital and labor are substitutes in the production process,
Denote the firm's optimal factor demand by k(p, w, r) and (p, w, r). Suppose that capital and labor are substitutes in the production process, i.e. fk 0. Now suppose the government decides to to impose a payroll tax t per unit of labor input. Assume that the prices p, w, r remain unaffected by this tax. Suppose the firm can respond in the short-run only by changing its labor input but not its capital input (which was chosen optimally before the tax was imposed)
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