Question

1. The following table gives information on the production capabilities of a country that uses labor and capital in its production process:

	Output Needed		Actual Production
Labor			Low Capital	High Capital
0	$0.0		$0.0	$0.0
100	187.5		375.0	450.0
200	375.0		562.5	637.5
300	562.5		675.0	825.0
400	750.0		750.0	900.0
500	937.5		787.5	937.5
600	1125.0		810.0	960.0

The “Labor” column gives the possible levels of labor. The “Output Needed” column gives the amount of output needed to sustain each possible level of labor/population. For example, we need $187.5 in output to sustain 100 people, $375 in output to sustain 200 people, etc. “Actual Production” gives the output that can be produced with each possible level of labor. There are two columns: the production associated with a low level of capital in the economy and the production associated with a high level of capital. So, with low capital, we see that 100 people are capable of producing $375 of output.

1. For a given level of labor, what happens to the level of production when capital is added to the economy? Why should we expect this to happen?
   
2. Use the values in the previous table to plot the subsistence line, production function with low capital, and production function with high capital. Assume that output is on the vertical axis and labor is on the horizontal axis.
   
3. What happens to the equilibrium levels of labor and output when the economy shifts from low to high levels of capital? Why does this happen?
   
4. Does this model allow for growth in the economy’s output? What, if anything, puts a limit on growth?

Answer 1

Solution(s):

Lets us first understand that with higher labor costs , a company will always incure higher level of costs , so we cannot expect the same growth increase in the output , The aggregate demand/aggregate supply model is a model that shows what determines total supply or total demand for the economy and how total demand and total supply interact at the macroeconomic level. Movements of either the aggregate supply or aggregate demand curve in an AD/AS diagram will result in a different equilibrium output and price level this is in relation to the ratio of labour vs Output.now here the aggregate supply curve shifts to the right as productivity increases or the price of key inputs falls, making a combination of lower inflation, higher output, and lower unemployment possible this means less labor will be required , on the ther hand , The aggregate supply curve shifts to the left as the price of key inputs rises, making a combination of lower output, higher unemployment, and higher inflation possible this means we will require higher number of labors. When an economy experiences stagnant growth and high inflation at the same time it is referred to as stagflation this means its is a stagnant stage or in other words is peak in a bell curve. The aggregate demand/aggregate supply model is a model that shows what determines total supply or total demand for the economy and how total demand and total supply interact at the macroeconomic level. Movements of either the aggregate supply or aggregate demand curve in an AD/AS diagram will result in a different equilibrium output and price level.The aggregate supply curve shifts to the right as productivity increases or the price of key inputs falls, making a combination of lower inflation, higher output, and lower unemployment possible.The aggregate supply curve shifts to the left as the price of key inputs rises, making a combination of lower output, higher unemployment, and higher inflation possible.When an economy experiences stagnant growth and high inflation at the same time it is referred to as stagflation.

AD AD Eo E1 0 2SR AS SRAS SRAS SRAS Y.Y.Y Y. Y Real GDP Real GDP (a) Productivity growth shifts AS to the right (b) Higher prices for key inputs shifts AS to the left