Explain the output and factor substitution effects of an increase in the price of capital on theDemand for labor by a firm that produces output using both capital and labor
What will be an ideal response?
If the price of capital rises, the factor substitution effect suggests that the firm will substitute away from the more expensive input (capital) toward the cheaper input (labor). This means that the demand for labor would increase. However, the increase in the price of capital will also increase the cost of production, leading the firm to produce less. This is the output effect. If the firm produces less, it needs a smaller level of all inputs including labor. This would cause a decrease in the demand for labor. The full effect on the demand for labor depends on the relative sizes of the two effects.
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New Keynesian inflation dynamics predicts that an increase in aggregate demand will generate, in chronological order
A) a rightward movement along a horizontal short-run aggregate supply curve, a short-run increase in real GDP, an upward shift in the short-run aggregate supply curve, and an increase in the price level. B) a leftward movement along a horizontal short-run aggregate supply curve, a short-run decline in real GDP, a downward shift in the short-run aggregate supply curve, and a decrease in the price level. C) an leftward shift in a vertical short-run aggregate supply curve, a short-run decline in real GDP, an upward movement along the short-run aggregate supply curve, and an increase in the price level. D) a rightward shift in a vertical short-run aggregate supply curve, a short-run increase in real GDP, an upward movement along the short-run aggregate supply curve, and an increase in the price level.
To determine the price elasticity of demand, we
A) need information on consumers' incomes. B) need to know how much is available. C) compare the percentage change in the quantity demanded to the percentage change in the price. D) compare the change in the quantity to the change in price. E) divide the quantity by the price.