Suppose that households’ wealth substantially increases. Using the capital market diagram (which shows the desired capital...

Suppose that households’ wealth substantially increases.

Using the capital market diagram (which shows the desired capital stock), show the effects of the change in wealth on MPK (demand for capital) and the user cost of capital (supply of capital).

Show the change in wealth on MPK (DEMAND FOR CAPITAL and the user cost of capital (SUPPLY OF CAPITAL)

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Expert Solution

MPk is defined as the additional production that a firm expereinces when there is an increase in one unit of capital .When the wealth of the households increases it implies that the consumption of the households has increased .The increase in consumption expenditure will lead to an increase in more investment in capital goods to produce more consumer goods .Hence the demand for capital will increase and there will be a rightward shift in the demand for capital .If there is an increase in MPK there is a rightward shift in the demand curve.

The first diagram depicts the equilibrium between the demand curve and the cost of capital.In the second diagram as there is an increase in wealth of households it will shift the demand curve to the right.

The supply of the capital will also increase as the household wealth increases the savings will also increase and thus the supply curve will also shift to the right.

Rahul Sunny answered 1 year ago

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