Question

Suppose large forest fires result in large destruction of capital. Describe how this shifts the investment demand function and the labor demand function.

Answer 1

AS A RESULT OF FALL IN CAPITAL STOCK, INVESTMENT DEMAND FALLS. ACCORDING TO KEYNES, INVSETMENT DEMAND DEPENDS ON RATE OF INTEREST (r) AND MARGINAL EFFICIENCY OF CAPITAL(MEC). THERE IS AN INVERSE RELATION BETWEEN RATE OF INTEREST AND INVESTMENT DEMAND. IN OUR CASE AS A RESULT OF DESTRUCTION OF CAPITAL ,PRODUCTION FALLS. IT LEADS TO INFLATION AND RESULTING IN HIGH INTEREST RATE BY THE MONETARY AUTHORITY. THE NET EFFCT IS THE FALL IN INVESTMENT.

                         MEC IS THE EXPECTED RETURN FROM MAKING AN INVESTMENT. AS A RESULT OF THE DESTRUCTION OF CAPITAL DUE TO FOREST FIRE, BUSINESS CLASS BECOME PESIMMISTIC AND MEC FALLS.. THIS WILL REDUCE FURTHER INVESTMENT. THERE IS A POSITIVE RELATION BETWEEN INVESTMENT DEMAND AND MEC. FALL IN MEC LEADING TO FALL IN INVESTMENT DEMAND. INVESTMENT DEMAND CURVE IS DOWNWARD SLOPING. IT SHIFTS TO THE LEFT.

                           THE DEMAND FOR LABOUR IS INFACT A DERIVED DEMAND FOR THE GOOD HE IS PRODUCING. AS A RESULT OF DESTRUCTION OF CAPITAL, PRODUCTION FALLS . SO LESS LABOUR IS NEEDED NOW. SO LABOUR DEMAND ALSO FALLS. LABOUR DEMAND CURVE IS DOWNWARD SLOPING.IT ALSO SHIFTS TO THE LEFT.