that are not ex goods on r services.They are the ehoushold disposable opposite of taxes:taxes reduce income, whereas transfer payment increase it.Examples of transfer payments include Social Security payments to the elderly,unemployment insurance,and veterans'benefits. 6.What makes the demand for the economy's output of goods and services equal the supply 6.Consumption,investment,and government purchases determine demand for the economy's output,whereas the factors of production and the production function determine the supply of output.The real interest rate adjusts to ensure that the demand for the conomy's goods equals the supply.At the ium interest rate,the demd forgoodsand suppy 7.Explain what happens to consumption,investment,and the interest rate when the government increases taxes. 7.When the go ernment increases taxes,disposable income falls s,and therefor consumption falls as wellThe decrease in consumption equals the amount that taxes increase multiplied by the marginal propensity to consume(MPC).The higher the MPC is,the greater is the negative effect of the tax increase on consumption.Because output is fixed by the factors of production and the productiontechnolog,a ernment purch ases ha ave not c the decreas in consumption must be offset by an increase in investment.For investment to rise,the real interest rate must fall.Therefore,a taxincrease leads to a decrease in consumption,an increase in investment,and a fall in the real interest rate. Problems and Applications 1.Use the neoclassical theory of distribution to predict the impact on the real wage and the real rental price of capital of each of the following events: .A wave of immigration ses the labor fore qu ke dest ome of the capital c.A technological advance improves the production function 1.a.According to the neoclassical theory of distribution,the real wage equals the marginal product of labor.Because of diminishing returns to labor an increase in thelabor fo causes th e marginal product of lab e,the wage falls b.The real rental price equals the marginal product of capitalIf an earthquake destroys some of the capital stock(yet miraculously does not kill anyone and lowerthe labor force),the marginal product of capital rises and,hence,the real rental price rises.that are not in exchange for goods or services. They are the opposite of taxes:taxes reduce household disposable income, whereas transfer payments increase it.Examples of transfer payments include Social Security payments to the elderly,unemployment insurance,and veterans’benefits. 6.What makes the demand for the economy’s output of goods and services equal the supply? 6.Consumption,investment,and government purchases determine demand for the economy’s output, whereas the factors of production and the production function determine the supply of output.The real interest rate adjusts to ensure that the demand for the economy’s goods equals the supply.At the equilibrium interest rate,the demand for goods and services equals the supply. 7.Explain what happens to consumption, investment, and the interest rate when the government increases taxes. 7.When the government increases taxes,disposable income falls,and therefore consumption falls as well.The decrease in consumption equals the amount that taxes increase multiplied by the marginal propensity to consume(MPC).The higher the MPC is, the greater is the negative effect of the tax increase on consumption.Because output is fixed by the factors of production and the production technology,and government purchases have not changed,the decrease in consumption must be offset by an increase in investment.For investment to rise, the real interest rate must fall. Therefore, a taxincrease leads to a decrease in consumption, an increase in investment,and a fall in the real interest rate. Problems and Applications 1. Use the neoclassical theory of distribution to predict the impact on the real wage and the real rental price of capital of each of the following events: a.A wave of immigration increases the labor force. b.An earthquake destroys some of the capital stock. c.A technological advance improves the production function. 1. a. According to the neoclassical theory of distribution, the real wage equals the marginal product of labor. Because of diminishing returns to labor, an increase in thelabor force causes the marginal product of labor to fall.Hence, the real wage falls. b.The real rental price equals the marginal product of capital.If an earthquake destroys some of the capital stock(yet miraculously does not kill anyone and lowerthe labor force), the marginal product of capital rises and, hence, the real rental price rises