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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.
We assumed that the country risk premium is exogenous in our analysis for simplicity. In reality, risk premium can fluctuate depending on the perceived economic outlook of a country. Let’s assume that a change in output affects the risk premium in the opposite way: an increase in output decreases the risk premium and a decrease in output increases the risk premium. Under this assumption, what happens to IS and LM curves, LRAS curve, real rental rate, investment, real exchange rate, real wage rate, and price level in short run and from short run to new long run if an economy is hit by an earthquake that lowers the existing capital stock without any change in the labor supply? Assume that the domestic country is small and it is operating under fixed exchange rate system.
