Suppose that a technological advance raises total factor productivity. Explain, step-by-step, how the economy adjusts to arrive at a new long-run equilibrium
What will be an ideal response?
The marginal products of both labor and capital increase, so both demand curves shift up. Since the factor supplies are fixed, there can be no increase in factor utilization, but output has risen, because both factors are more productive. At the original factor prices, there is now excess demand, which causes both the real wage and the rental price of capital to rise. These increases in factor prices distribute the increased output to the inputs, so that the income share of each input in total output does not change. The factor prices stop rising when they are equal to the higher marginal product that results from the improved technology.
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A) above, rises B) above, falls C) below, rises D) below, falls
Refer to Figure 10.4. Suppose the economy's equilibrium starts out with an output gap of 1, and real GDP increases so the output gap increases to 2
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