PS 2 Fall 08 Ans - Problem Set 2 FE312 Fall 2007 Rahman...

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Problem Set 2 FE312 Fall 2007 Rahman Some Answers 1) Use the neoclassical theory of distribution to predict the impact on the real wage and the real rental price of capital of each of the following events (illustrate graphically, using two graphs for each case, one for the labor market and one for the capital market, and explain in one or two sentences): a. A wave of immigration increases the labor force. According to the neoclassical theory of distribution, the real wage equals the marginal product of labor. Because of diminishing returns to labor, an increase in the labor force causes the marginal product of labor to fall. Hence, the real wage falls. Because capital is now RELATIVELY more scarce, it becomes more productive – hence demand for capital by firms rises. b. An earthquake destroys some of the capital stock. Page 1 of 4 w L r K S D S D S’ D’ w L r K S D S D S’ D’
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Problem Set 2 FE312 Fall 2007 Rahman The real rental price equals the marginal product of capital. If an earthquake
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