Question

Suppose a series of terrorist attacks destroys half the capital in the United States but does not affect the population. What will happen to potential output and to the real wage?

Answer 1

Answer : Due to destroyed half capital the production level will decrease. But aggregate demand will not change as the population is not affected. In this situation the long run aggregate supply curve will shift to leftward on existing aggregate demand curve. As a result, the potential output will decrease and price will increase.

Due to decrease in output level the labor demand will decrease. This will decrease the nominal wage rate. And due to high price level with lower nominal wages the real wage will decrease.

So, here both potential output and real wage will decrease.