Homework 1
Macroeconomics I, UC3M
Question 1: Indicate the effect on the real rental price of capital and the real wage
under the following circumstances:
a. An immigration wave increases the labor pool.
b. An earthquake destroys part of the countries’ capital stock.
c. Technological advancement increases productivity.
Question 2: Assume the following production function: K 1/3 L4/3 .
a. Does the function have constant, decreasing, or increasing returns to scale?
b. Has the function decreasing marginal returns to capital? To labor?
Question 3: Suppose that an economy’s production function Y = AK 0.3 L0.7 .
a. What fractions of income do capital and labor receive?
b. Suppose that immigration increases the labor force by 10 percent. What happens to
total output (in percent)? The rental price of capital? The real wage?
c. Suppose that a gift of capital from abroad raises the capital stock by 10 percent. What
happens to total output (in percent)? The rental price of capital? The real wage?
d. Suppose that a technological advance raises the value of the parameter A by 10 percent.
What happens to total output (in percent)? The rental price of capital? The real wage?
Question 4: Consider a Cobb-Douglas production function with three inputs: K is
physical capital, L is raw labor, and H is human capital. The production function is: Y =
L1/3 H 1/3 K 1/3 .
a. Calculate the marginal product of raw labor. How is it affected by human capital?
b. Give an expression for the marginal product of human capital. How is it affected by
raw labor?
c. What is the share of national income for a) raw labor, b) human capital? In national
accounting, how high is the labor share of production?
d. A low skilled worker is paid the marginal product of raw labor. A high skilled worker
receives the sum of marginal products from raw labor and human capital. Calculate
the relative wage of low to high skilled labor. How does the amount of human capital
affect the relationship?
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e. Assume the government can increase high skilled workers by providing university
grants. How does an increase in grants affect wage inequality?
Question 5: Consider an economy with the following Cobb-Douglas production:
Y = K 0.3 L0.7
The economy has 1000 units of capital and a labor force of 1000 workers.
a. Derive the equation describing labor demand in this economy as a function of the real
wage and the capital stock.
b. What is the real wage? In this equilibrium, what are employment, output, and the
total amount earned by workers?
c. Differently from the standard case with perfectly competitive labor markets, consider
the introduction of a minimum wage policy. In particular, suppose that the parliament,
concerned about the welfare of the working class, passes a law requiring firms to pay
workers a real wage of 1. How does this wage compare to the equilibrium wage?
d. Parliament cannot dictate how many workers firms hire at the mandated wage. Given
this fact, what are the effects of this law? Specifically, what happens to employment,
output, and the total amount earned by workers?
e. Will the Parliament succeed in its goal of helping the working class? Explain?
