Question

Consider the Real Business Cycle Model studied in class. The equilibrium effects of a future increase in total factor productivity (z' using the notation in class) include:

		a decrease in the real wage and a decrease in the real interest rate.
		an increase in the real wage and a decrease in the real interest rate.
		a decrease in the real wage and an increase in the real interest rate.
		an increase in the real wage and an increase in the real interest rate.

Answer 1

OPTION(D) : is correct

an increase in the real wage and an increase in the real interest rate.

An increase in Factor Productivity leads to an increase in GDP.

The higher level of economic activity increases labor demand from LD to LD’. an increase in the demand for labor increases both the number of people employed from L to L’, but also increases the real wage rate from w to w’.

i.e. An increase in Factor Productivity leads to an increase in real wage.

Higher level of economic activity increase the demand  for Loans from DL to DL’, thus raising the interest rate as well as the quantity of loans being made from B to B’.

i.e. An increase in Factor Productivity leads to an increase in the level of investment.  It also leads to a higher real interest rate.