Answer to Question #152130 in Economics of Enterprise for Elsa

Question

Suppose capital share of output α increased suddenly and permanently in a small open market economy. What happens to real wage rate, real rental rate, price level, real interest rate, real exchange rate, consumption, and savings in long run and very-long run? Assume a Cobb Douglass production function.

Answer 1

The Cobb-Douglas Function takes the form of $Q=K^{\alpha} L^{\beta}$ in which Q=output, K=capital, L=labour, and alpha and beta represent input shares of capital and labour respectively. In this form we have used CD as a production function.

Capital's share is equal to the gold byen rule savings rate, if the capital share increases suddenly that means the savings will increase

The rise in K shifts the capital supply curve to the right, which reduces the equilibrium real rental price of capital and increases the equilibrium quantity of capital. Because the rise in K increases M Price Level, the labor demand curve shifts right. This causes the equilibrium real wage to increase, but has no effect on the equilibrium quantity of labor employed. The consumption will also increase.