Question

1. Use the neoclassical theory of distribution to predict the impact on the real wage and the real rental price of capital of each of the following event:

a. A wave of immigration increases the labor force.

b. An earthquake destroys some of the capital stock.

c. A technological advance improves the production function.

d. High inflation doubles the prices of all factors and outputs in the economy.

Answer 1

a) Increase in labor force increases the supply of labor. This reduces the real wage rate as labor supply curve shifts right. Since labor is now cheaper to hire, capital is less hired so demand for capital declines. This reduces the real rental price of capital

b) Since capital stock is reduced, supply of capital is decreased. This raises the real rental price of capital. Now that capital is expensive to hire, demand for labor increases. This raises the real wage rate as demand curve shifts right

c) Since technology raises the productivity of labor and capital, their demand increases. This raises both the real wage rate and real rental price of capital

d) Inflation reduces the real values so both the real wage rate and real rental price of capital experience a decline.