Question

A storm destroys several factories, thereby reducing the stock of capital. What effect does this event have on factor markets? a. Wages and the rental price of capital both rise. b. Wages and the rental price of capital both fall. c. Wages rise, and the rental price of capital falls. d. Wages fall, and the rental price of capital rises.

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In this problem we know that the supply of capital decreases

As the supply of capital decreases, the cost of capital (rental price) is going to increase because the supply will be insufficient to meet demand.

In terms of wages, as these factories shut down, the labor will have to relocate to other factories. This means there is an excess supply of labor, and when you have this excess supply, wages fall until a new equilibrium is found.

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