The
following graph shows the marginal product of
capital and the user cost of capital. Assume that
the economy is currently at point A, with the
capital stock equal to K*
a. All other things being equal, how would you
expect Federal Reserve policy that increases
the money supply to change the user cost of
capital? What effect would you expect this
change in the user cost of capital to have on
investment and the capital stock in the short
run? Show your answer on the graph.
b. Now return to the original graph and suppose
that there is an improvement in technology
that makes capital more productive.
How would the productivity increase change
investment and the capital stock in the short
run? Show your answer on the graph.