Suppose that reduced barriers to international financial transactions cause an increase in the economy's supply of capital. Explain, step-by-step, how the economy adjusts to arrive at a new long-run equilibrium
What will be an ideal response?
The increase in the supply of capital (rightward shift of the supply curve) causes an excess supply at the original rental price, and the excess supply causes the price to fall. Since the price of capital falls below its marginal product, firms buy more capital. The increase in capital utilization causes an increase in the marginal product of labor, so the demand for labor increases (the demand curve for labor shifts up). Since the supply of labor is fixed, there is no change in the quantity of labor in use, but the real wage rises to equal the higher marginal product. The rental price of capital stops falling when the quantity of capital in use is equal to the supply of capital. The increase in output is distributed between the capital and labor inputs, so that the share of each factor in total income is unchanged from the original equilibrium. The (unchanged) labor inputs receive a higher wage; each unit of capital receives a reduced payment, but capital's share of total income is increased because of the larger number of capital units receiving payment.
You might also like to view...
Why do private markets fail to account for externalities?
a) The government can easily correct any adverse effect on the market that externalities may cause. b) Externalities don't occur in private markets. c) Decision makers in the market fail to take into account the external effects of their behaviour. d) Sellers include costs associated with externalities in the price of their products.
If the price of butter increases, the demand for margarine
A) will be unchanged. B) will shift outward. C) will shift inward. D) will kink into an S-curve.