Question

Show in the graph and also describe the following situation: The government decided to subsidize the...

Show in the graph and also describe the following situation: The government decided to subsidize the capital of the automobile industry. In other words, the price of capital has dropped from r1 to r2 for the enterprise. What effect does this policy have on the demand for capital and labor in the automotive industry in the short run and long run?

Please include a graph to explain.

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Answer #1

When the government subsidizes capital of automobile industry, the price of capital falls which will leads to a higher desired capital stock. This will encourage firms to substitute labor with capital in short run as the price of capital has fallen.The effect of above policy in long run will be dependent on nature of policy.

If the above policy change is permanent, firms will continue production with changed inout mix otherwise shift to the original input mix when the subsidy is rolled back.

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