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Assume that the economy is operating in a classical world. Assume that the capital stock increases...

Assume that the economy is operating in a classical world. Assume that the capital stock increases in such a way that it shifts the aggregate production function upwards increasing its slop. Describe the effect of this increase in capital stock on the demand and supply of labor, real wages, and the level of RGNP, the level of employment, the AS curve, and price.

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Answer - Due to the rise in the capital stock of the economy , the marginal product of the labor will rise. This is when the capital and labor act as complements to each other. As a result of this, the demand for the labor will rise , leading to the rise in the wages of labor. This rise in wage will lead to the rise in supply of labor. The rise in the capital stock along with rise in labor , will lead to rise the Aggregate supply. Since the AS curve will shift right , this will lead to rise in RGDP and fall in price level. Due to greater supply , greater labor supply and demand , the employment rate in the economy will rise.

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