Use the classical theory (MPK and MPL) to predict the impact on the real wage and...
Use the classical theory (MPK and MPL) to predict the impact on the real wage and the interest rate (price of capital) of each of the following events (Hint: remember the model where we explained the demand for labour and capital and that the supply of inputs is constant):
b. An investment tax break
Homework Answers
Solution
Use the classical theory (MPK and MPL) to predict the impact on the real wage and the interest rate (price of capital) of each of the following events
b.
Due to investment tax break, investment incentives will rise and more investment will be made. Due to this increase in investment, MPK will fall (assuming diminishing returns).
Using labor market equilibrium condition:
Price of capital = MPK will also fall.
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