4. Use the Neoclassical model of investment to explain the impact of each of the following

Question

events on the real rental price of capital, the cost of capital and investment:
A. Anti-inflationary monetary policy raises the real interest rate
B. An earthquake destroys some of the capital stock.
C. Immigration of foreign workers increases the size of the labor force�

Answer 1

A. Anti-inflationary monetary policy raises the real interest rate:
In the Neoclassical model of investment, an increase in the real interest rate would lead to a decrease in investment as the cost of borrowing capital increases. This would result in a decrease in the demand for capital, leading to a decrease in the real rental price of capital. Additionally, the cost of capital would also increase, further discouraging investment. Overall, this event would likely lead to a decrease in investment and a decrease in the real rental price of capital.

B. An earthquake destroys some of the capital stock:
In this scenario, the destruction of capital stock would lead to a decrease in the supply of capital. This decrease in the supply of capital would drive up the real rental price of capital as firms compete for the limited available capital. Additionally, the cost of capital would also increase as the remaining capital becomes more scarce. However, the destruction of capital stock may also lead to an increase in investment as firms seek to replace the lost capital. Overall, this event would likely lead to an increase in the real rental price of capital and an increase in investment.

C. Immigration of foreign workers increases the size of the labor force:
In the Neoclassical model of investment, an increase in the size of the labor force would lead to an increase in the returns to capital as firms are able to hire more workers and produce more output. This would lead to an increase in the demand for capital, driving up the real rental price of capital. Additionally, the cost of capital would also increase as the increased demand for capital leads to higher prices. Overall, this event would likely lead to an increase in the real rental price of capital and an increase in investment.