Analytical Question.
Answer the following question based on the standard models of analysis developed in class. The information in the various parts of the question is sequential and cumulative. Be sure to show and discuss each individual effect and not just the net effect of the exogenous shocks.
1. The Production Function, the Labor Market, and the Capital Market. Suppose that the economy is initially at its potential output level with a labor supply curve that is a positive function of the real wage rate and a capital stock that is fixed.
a. Based only on this information use a Production Function diagram (on the left) and a Labor Market diagram (on the right) to clearly and accurately show the economy's initial equilibrium levels of (1) economic output, (2) employment, and (3) the real wage rate. These diagrams should be drawn in BLACK.
b. Based only on the information above, use a Production Function diagram (on the left) and a Capital Market diagram (on the right) to clearly and accurately show the economy's initial equilibrium levels of (1) economic output, (2) the capital stock, and (3) the real rental cost of capital. These diagrams should be drawn in BLACK.
c. Provide an economic explanation of what you have shown in your diagrams above
d. Suppose that there is a significant increase (relative to the growth in the labor force) in the number of workers who are retiring. Incorporating only this additional information, clearly and accurately show in your diagrams above what effects this would have on equilibrium (1) economic output, (2) employment, (3) the real wage rate, (4) the capital stock, and (5) the real rental cost of capital. These effects should be drawn in RED.
Provide an economic explanation of what you have shown in your diagrams above. Discuss what happens to equilibrium (1) economic output, (2) employment, (3) the real wage rate, (4) the capital stock, and (5) the real rental cost of capital. Be sure to explain why these changes take place.
e. In addition, suppose that the retiring workers possessed higher than average work skills. Incorporating only this additional information, clearly and accurately show in your diagrams above what effects this would have on equilibrium (1) economic output, (2) employment, (3) the real wage rate, (4) the capital stock, and (5) the real rental cost of capital. These effects should be drawn in BLUE.
Provide an economic explanation of what you have shown in your diagrams above. Discuss what happens to equilibrium (1) economic output, (2) employment, (3) the real wage rate, (4) the capital stock, and (5) the real rental cost of capital. Be sure to explain why these changes take place.