Question

Assume realistically that the U.S. receives capital flows from the rest of world. In
addition, assume that foreign capital increases the level of total factor productivity from 1 to 2, by funding research and developments of new technologies. Do foreign capital inflows shift the supply curve, or the demand curve, or both curves in the capital market? Depict a diagram and explain effects of foreign capital inflows on the MPK, and the real rental rate of capital.

Answer 1

If the U.S. receives capital flows from the rest of world and foreign capital increases the level of total factor productivity from 1 to 2 by funding research and developments of new technologies, then foreign capital inflows will shift the supply curve rightward in the capital market, because the foreign caapital inflows will increase. As a result the real rental rate of capital will decrease.