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Suppose that households change their preferences so that they wish to consume more and save less in the current year. That is, current consumption, C1, rises for a given interest rate, and for a given current and future income.

a. Determine the effects on the labor market. What happens to labor input, L, and real wage rate, w/p?

b. Determine the effects on the market for capital services. What happens to the real rental price, R/P? What happens to the interest rate?

c. What happens to consumption, investment, and what happens over time to the stock of capital, K?

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Yusra AneesLv10
28 Sep 2019
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Related questions

Suppose that an economy's production function is cobb-douglas with parameter α = 0.3

a. What fractions of income do capital and labor recieve?

b.Suppose that immigration increase the labor force by 10 percent. What happens to total output (in precent)? The rental price of capital? the real wage?

c. Suppose that a gift of capital from abroad raises the capital stock 10 percent. What happens to total output (in percent)? The rental price of capital? The real wage?

d. Suppose that a technological advance raises the value of the parameter A by 10 percent. What happens to total output (in perecnet)? The rental price of capital? The real wage?

For concreteness, assume that the production function is Y = 100K0.3L0.7and assume that the economy starts with K = 100 and L = 100. Using this information, calculate exact percentage changes for total output, the real rental rate, and the real wage rate.

Consider an economy with a representative consumer like the one described above, and a representative firm like The production function of the firm is given by zF (K, N) where: F (K, N) = KαN β and α + β < 1.The firm can hire workers in the labor market at a wage w and can rent capital market at a rental rate r (that is, the firm can rent K units of capital for which it would have to pay rK). For this problem assume that there is one unit of capital owned by a foreign investor. The investor’s capital supply is perfectly inelastic (that is she will supply one unit of capital at any rental rate).

a) (2.5 points) The equilibrium rental rate must be such that the demand and supply of capital are equalized. Find the equilibrium rental rate. Hint: You can express the equilibrium rental as a function of the wage. For this is is useful to use the FOC of the firm with respect to capital.

b) (2.5 points) The equilibrium wage must be such that the demand and supply of labor are equalized. Find the equilibrium wage. Hint: You can get an easier expression for the labor demand when you use the labor demand as a function of capital (obtained by combining the firm’s FOC) and set capital to its market clearing value. Then you can solve for the wage. Remember to replace by the equilibrium interest rate from the previous point.

c) (2.5 points) With the equilibrium prices solve explicitly for the equilibrium labor. Hint: You can get a better expression for the equilibrium labor using the labor supply and replacing by the wage you obtained above. d) (2.5 points) In equilibrium, what happens to the wage, interest rate, labor and consumption when the government increases the labor taxes? Hint: Find out first what happens to the wage, and then use your result for the equilibrium interest rate to find out what happens to that variable. The effect on labor can be obtained directly from your answer to (c) or from the FOC of the firm with respect to labor. Finally, get the effect on profits before finding out the effect that extra taxes have on consumption.

Choose the correct answer from the brackets:

A)The demand for money is mainly influenced by three variables: r (the short-term interest rate), Y (real GDP), and P (the aggregate Price level). Suppose r rises, but Y and P are unchanged. What happens to the quantity of money demanded?

r is both the opportunity cost of holding money and the reward for holding bonds. Thus, an increase in r causes people to want to hold (more/less ) of their wealth in the form of money and ( more/less) in the form of bonds to take advantage of the higher interest rate.

B)

Suppose real income (Y) rises while the quantity of money in the economy stays the same. What happens to money demand?

The supply of money does not automatically rise when the production of real goods and services (Y) rises. However, the collective demand for money by firms and households does rise. To get this money firms and households attempt to (buy more/ sell some of their /more /less bonds).

Thus, an increase in Y causes people to want to hold (buy more /sell some of their / more /less) of their wealth in the form of money and (buy more / sell some of their / more / less ) in the form of bonds.

C)Suppose the price level (P) rises, but Y and r are unchanged. What happens to money demand?

If Y is unchanged, people will want to buy the same amount of goods and services as before. However, since P is higher, they will need (more / less) money to do so.

Hence, an increase in P causes people to want to hold (more / less) of their wealth in the form of money and (more / less) in the form of bonds.

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