1. 8. Consider the following example, which follows the analytical framework of Goldin and Katz (
2008). (a) Suppose the economy uses just two inputs, capital (K) and labor (L). If the cost of each
unit of capital (what we called the rental rate, r ) is $5 and the cost of each unit of labor (the wage
rate, w ) is $4, and the economy spends $100 total in costs of production, draw the isocost curve
for the economy with capital on the y-axis. (b) Based upon (a) above, depict an isoquant where, at
the optimal production mix, the economy uses five times as much labor as it does capital. (c) Now,
on the same graph, illustrate tchnological change that is capital-biased. Another term for this is
"labor saving" technical change. Based upon your depiction of the technological change, identify
the new optimal input mix - has it indeed been "labor saving"? (d) If the capital/labor ratio does not
fully adjust as you depicted in part (c), what will be the implication for the w/r ratio? If, as is the
case in the US, most capital is owned by the relatively well off and the relatively poor rely on
income from their labor, what would be the implication for economic inequality?