Answer to Question #143295 in Macroeconomics for marita

Question

Suppose the government is planning to subsidize τ fraction of the cost of renting capital
such that 0 < τ < 1. How would this affect real wage rate, real rental rate, real interest rate and price level
in long run and very-long run in a closed market economy?

Answer 1

$$Solution$$

In the long run in a closed market economy. Then the effect will be as follows;

a) Real wage rate- The government provide subsidy of the cost of renting capital the domestic production capacity will increase in the economy working labor demand also increase in the economy and real wage rate also increases.

b) Real Rental Rate-As the government provides subsidy the real rental rate will decrease.

c) Real interest Rate- When those in business are subsidized by the government, the production capacity increase and they get a huge amount profit. Also banks provide loans to these individuals at a discounted rate and this leads to a decrease in the real interest rate.

d) Price level-The production capacity of the economy will increase due to the introduction of the government subsidy which in turn will decrease the price level in the long run in a closed market economy.