Question

Consider the goals of the recent cut in corporal profits taxes. What if that tax cut were to lead to an increase in the US capital stock? Draw a graph illustrating a labor market in equilibrium. Illustrate and explain the effect of an increase in the capital stock. What will be the total impact on GDP?

Answer 1

Answer 2

Graph: Labor Market Equilibrium

• Initial Equilibrium:

• X-axis: Quantity of Labor ($L$)

• Y-axis: Wage Rate ($W$)

• Initial Curves:

• $D_L$ (downward-sloping)

• $S_L$ (upward-sloping)

• Intersection at ($L_0$, $W_0$).

• Wage ($W_0$) and employment ($L_0$) are determined by labor demand ($D_L$) and supply ($S_L$).

• Graph Labels:

2. Effect of Increased Capital Stock

• Corporate Tax Cut → Higher Investment → Larger Capital Stock ($K\uparrow$).

• Labor Demand Shifts Right: More capital makes workers more productive, increasing demand for labor.

• New Labor Demand: $D_L^{\mathrm{\prime }}$ (rightward shift).

• New Equilibrium: ($L_1$, $W_1$) with higher wages and employment.

3. Total Impact on GDP

• GDP Increases due to:

1. Higher Employment ($L\uparrow$) → More output.

2. Higher Productivity (from $K\uparrow$) → Output per worker rises.

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Key Graph Illustration

 

Wage Rate (W)
  |
W1 |----● New Equilibrium (D_L' intersects S_L)
   |   / 
W0 |--●-- Initial Equilibrium (D_L intersects S_L)
   | / 
   |/___________________
      L0  L1   Quantity of Labor (L)

Summary:

• Labor Market: Wages ($W\uparrow$) and employment ($L\uparrow$) rise.

• GDP: Expands due to higher productivity and employment.