Effect of Change in Input Price on Input Use
This effect is similar to what we discussed in the case of indifference curves and it can be illustrated diagrammatically in the same manner as price effect on consumer’s equilibrium by indifference curves.. The theta! effect on the use of the input of a change in its price is made up of two components: the substitution effect and the output effect. The substitution effect is the effect on the use of the input due exclusively to the. change in the relative price of the inputs, the output remaining the same. This effect is invariably negative, because a rise in the price of an input must lead to a reduction in its use and a fall in price to its greater use. The output erred indicates the effect on input use due to change in the level of output, the input price remaining unchanged. This effect, too. is always negative, because increase in cost reduces both the output, and vice versa.