Assume that the production function is given by Y = AK 0.5 L 0.5 , where Y is GD

Question

Assume that the production function is given by Y = AK0.5L0.5, where Y is GDP, K is capital stock, and L is labor. The parameter A is equal to 10. Assume also that capital is 100, labor is 400, and both capital and labor are paid for their marginal products.

1.What is Y?

2.What is the real wage of labor?

3.What is the rental price of capital (the amount of output paid per unit of capital)?

4.Find the real wage of labor when the available labor increases by 40% ceteris paribus.

5.As a macroeconomist for Country Picolia, you are asked to advise the government on an immigration policy which would lead to entry of more workers into Picolia. What advice would you give the government?

Explanation / Answer

1. Y=A(K•L)

= 10*10*20= 2000

2. Real Wage of labour=Nominal wage/ price level

=2000*0.5/400

=2.5

3. Rental price of capital = Y/capital

=2000*0.5/100

=10(keeping P constant but in real macro economics P isin't constant and depends on few factors)

4.Real wage of labour=2000*0.5/560

=1.78

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