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.
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Appendix: Common value auctions with open bidding necessarily entail
a. asymmetric information b. ascending prices c. more than two bidders d. amendment of bids e. sealed final offers.
As extraction of a nonrenewable resource increases, the supply curve shifts up because:
a. more substitutes become available. b. competition among the existing suppliers intensifies. c. the marginal cost of extracting any given amount increases. d. the resource finds alternative usage. e. the resource becomes less productive.
Large sport utility vehicles (SUVs) add significantly to air pollution because they do not have to meet passenger auto emission standards. The purchase of an SUV
a. adds less to GDP since the pollution costs are subtracted from GDP. b. adds to nominal but not real GDP because of the pollution costs. c. is a net loss to GDP because the pollution costs are so large. d. increases GDP.
In which of the following statements are the terms "demand" and "quantity demanded" used correctly?
A. When the price of ice cream rose, the demand for both ice cream and ice cream toppings fell. B. When the price of ice cream rose, the quantity demanded of ice cream fell, and the demand for ice cream toppings fell. C. When the price of ice cream rose, the demand for ice cream fell, and the quantity demanded of ice cream toppings fell. D. None of these statements use the terms correctly.