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*1.

a. Increases in the money supply when the interest rate is near 0% have the effect of lowering real interest rates but not nominal interest rates. All other things being equal, how would you expect asset purchase programs, such as those that the Fed implemented in 2009€“2011, to change the user cost of capital? What effect would you expect this change 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? Revise the graph to support your answer.

Transcribed Image Text:

uc1 MPKe K. Capital stock, K