Show in the graph and also describe the following situation: The government decided to subsidize the...

Show in the graph and also describe the following situation:

The government decided to subsidize the capital of the automobile industry. In other words, the price of capital has dropped from r1 to r2 for the enterprise. What effect does this policy have on the demand for capital and labor in the automotive industry in the short run and long run?

Expert Solution

The scenario indicates that the government has decided to subsidize the borrowing cost of capital for automobile industry. In this case, the automobile industry will be able to borrow at a lower or subsidized interest rate against the prevailing market rate. This will increase the demand for loans by the automobile industries in the short run and capital being one of major input factor so the manufacturing cost will be lower. That may increase the production and demand for labor in the industry.

The net effect will be nullified in the long run as the subsidy will be removed. In the existence of subsidy, the lower cost of capital will encourage many players to borrow and again many players will compete for limited capital which raise the demand for capital thus raising the borrowing cost again to market clearing level.

Rahul Sunny answered 6 months ago

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Show in the graph and also describe the following situation: The government decided to subsidize the...

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