Question

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:A. A (one-time) wave of immigration increases the labor force.
B. An earthquake destroys part of the capital stock.
C. A technological advance improves production.
D. High inflation doubles the price of all factors of production and output.

Answer 1

Answer:

a. A (one-time) wave of immigration increases the labor force.

According to neoclassical economists, real wage = marginal product of labor. As more labor is available, the marginal product of labor will decrease (law of diminishing marginal returns). Therefore, since the marginal product of labor decreases, the real wages will also decrease.

Since there is more labor available, even though the capital stock remains the same, total output should increase. As total output increases, the real rental price of capital (interest) will increase.

b. An earthquake destroys part of the capital stock.

According to neoclassical economists, real rental price of capital = marginal product of capital. A decrease in the capital stock will result in an increase in the marginal product of capital. This will increase the real rental price of capital.

Since the capital stock decreases, additional labor will produce less additional output, reducing the marginal product of labor. Since the marginal product of labor decreases, the real wage will decrease also.

c. A technological advance improves the production.

Technological improvements generally increase both marginal product of labor and marginal product of capital, therefore, real wages will increase and real rental price of capital will also increase.

d. High inflation doubles the price of all factors of production and output.

Inflation rate has no effect on real wages and real rental price of capital. The effects are only on nominal wages and nominal rental price of capital.