Q1 Factor prices and income6 Points

Suppose that the production function of the economy is:

Y=AK^0.5L^0.5

Consider the following hypothetical scenario regarding a decline in a country's capital stock. An economy is initially in equilibrium with a capital stock K1 and an initial labor supply L. Suppose that a natural disaster destroys half of the country's capital stock so that K2=0.5*K1. Thankfully none of the population was hurt so the labor supply is unchanged.

Q1.1

Find the ratio of output after the capital destruction to output before the capital destruction Y2/Y1

Report your answers as decimals rounded to at least three decimal places.

Q1.2

Find the ratio of the new real wage to the initial real wage:

(W/P)₂ / (W/P)₁

Report your answers as decimals rounded to at least three decimal places.

Q1.3

Find the ratio of the new real rental rate to the initial real rental rate:

(R/P)₂ / (R/P)₁

Report your answers as decimals rounded to at least three decimal places.