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Suppose that there has been an earthquake that destroyed part of the capital stock in the...

Suppose that there has been an earthquake that destroyed part of the capital stock in the economy. According to the neoclassical model of investment, what is the immediate impact of the earthquake on the real cost of capital, the rental price of capital, and the business fixed investment?

Answer: No change in the real cost. Increase in the rental price due to increased MPK. The business fixed investment increases.

Note: I don't understand the process to get this answer.

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Answer #1

An earthquake destroys part of the capital stock. So, the producers will be in greater demand for capital. This will cause the current capital stock to be more productive and push the real rental price up.

After the earthquake the workers will have less capital to work with so, the marginal product of capital will be increased.

This is a condition when the profit rate will be high and firm finds it profitable to accumulate more capital stock. So, it will increase the investment.

Because labor is now relatively more abundant, it becomes less productive. So, the demand for labor by firms will be increased, but not the cost of capital.

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