Consider a ?firm for which production depends on two inputs; labor and capital with prices w and r; respectively. Initially the fi?rm faces prices of w = 6 and r = 4: These prices then shifts to w = 4 and r = 2:

a) In which direction will the substitution effect change the ?rm?s capital and employment stock?

b) In which direction will the scale effect change the ?rm?s capital and employment stock?

c) Can we say conclusively whether the rm will use more or less labor? More or less capital?