Dominick Salvatore Schaums Outline of Microeconomics, 4th edition Schaums Outline Series 2006

140 THEORY OF PRODUCTION [CHAP. 6
6.20 Separate the output effect from the total effect of the factor price change in Problem 6.19. What is the
size of the substitution effect? What does this substitution effect measure?
We can separate the output effect from the total effect of the price change by shifting isocost 4 down and parallel
to itself until it is tangent to isoquant II. What we get is isocost 4 0 . (The downward shift refers to a reduction in
TO; the parallel shift is necessary so as to retain the new set of relative factor prices.)
Fig. 6-20
Thus,
Fig. 6-21
Total effect ¼ Substitution effect þ Output effect
MW ¼ MZ þ ZW
Note that the substitution effect is given by a movement along the same isoquant and measures the degree of
substitutability of labor for capital in production, resulting exclusively from the change in relative factor prices.