Question

Scenario: Two economies, A and B, have identical aggregate production functions with diminishing returns. In both economies, capital and labor are equally important for production. Economy A has twice as many efficiency units of labor as economy B. Economy B has twice as much physical capital stock as economy A.

Refer to the scenario above. Over time, economy A develops sophisticated technology, and human capital becomes less and less valuable in the production of goods and services that require more and more physical capital. How will this affect economy A's aggregate production function?

A) It will shift up and become less steep if physical capital stock is held constant.

B) It will shift up and become less steep if total efficiency units of labor are held constant.

C) It will shift to the left if physical capital stock is held constant.

D) It will shift to the left and become steeper if total efficiency units of labor are held constant.

Answer 1

If we are holding capital stock as constant, the production function should become less steep because the efficient labor is now less productive. If we are holding the labour units constant, then the production function should become more steep because the technology has increased the relative value of capital. In both the cases production function will shift up.

Select option A.