Question

Suppose the current level of output is 100 and productivity is increasing over time. If the elasticities of output with respect to capital and labour are 0.5 and 0.5 respectively, a 10% increase in capital combined with a 5% increase in labour would increase the current level of output to

Question 7 options:

	110
	107.5
	105
	a value greater than 107.5

Answer 1

Given that,

Current level of output = 100

Elasticity of output w.r.t to capital = 0.5

Elasticity of output w.r.t to labour = 0.5

Increase in capital = 10%

Increase in labour = 5%

Effective increase in capital:

= Elasticity of output w.r.t to capital * Increase in capital

= 0.5 * 10%

= 5%

Effective increase in labour:

= Elasticity of output w.r.t to labour * Increase in labour

= 0.5 * 5%

= 2.5%

Total increase in output:

= Effective increase in capital + Effective increase in labour

= 5% + 2.5%

= 7.5%

Increase in output:

= 7.5% * Current level of output

= 7.5% * 100

= 7.5

Now, the current level of output increases to:

= 100 + 7.5

= 107.5

Therefore:

Correct option: 107.5

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