Question

1. As capital increases, the marginal product of capital ___________.

2. The equation which relates real, nominal and inflation rates is called the _____ equation.

3. a. Show what will happen in both the loanable funds market and the bond market if people become more patient. (Two graphs)

b. Show the effect of this on the steady-state levels of capital and output.

Answer 1

Question 1

Marginal product of a factor input refers to the increase in total output when one more unit of that factor input is employed.

Initially, as a factor input is increased then such increase leads to increase in total output at increasing rate and thus marginal product of factor input increases as well.

However, continuous increase in the quantity of factor input leads to increase in total output but at decreasing rate and thus marginal product of factor input declines.

Capital is also a factor input.

So, in similar sense,

As capital increases, the marginal product of capital decreases.

Question 2

Real interest is the difference between the nominal interest rate and the inflation rate.

Thus, in a sense, real interest rate is the rate adjusted for inflation. It indicates the actual real return that is received or paid.

This relation is established by the Irving Fisher through following equation -

Real interest rate = Nominal interest rate - Inflation rate

Thus,

The equation which relates real, nominal and inflation rates is called the Fisher equation.