Answer to Question #220230 in Macroeconomics for Nis

Question

If capital stock of a nation rises, what will be its effect on output, employment and the 

real wage? Explain in the context of Classical model using diagrams.

Answer 1

In classical model, an increase in capital stock of a nation will leads to change in output by the way of affecting the aggregate Production function and labour market. As per the classical model, capital output is determined by the employment of labour. The level of output is determined by the demand for and supply of labour. In the figure, the wage rate is determined at the point where the positively sloping labour supply curve is tangent to the negative sloped demand curve. An capital stock of a nation increases, it increase productivity of labour which will cause Increase in demand for labour . Aa a result labour supply curve will shift to the rate as LD2 and this will raise the real wage from W/p1 to W/p2 . As wage increases supply of labour will also increases. Ann increase in output will increase employment from N1 to N2 in the economy.