An economy initially has 200 units of physical capital per worker. Each year, it increases the amount of physical capital by 10%. According to the aggregate production function for this economy, each 1% increase in physical capital per worker, holding human capital and technology constant, increases output per worker by 0.25%. If there is no inflation and output per worker is initially $1,000, what does the estimated output per worker equal after one year

$1,025

Explanation:

Given that,

Initial physical capital per worker = 200 units

Percentage increase in physical capital per year = 10%

Initial output per worker = $1,000

Holding human capital and technology constant,

1% increase in physical capital per worker = 0.25% increase in the output per worker

Hence, if there is a 10% increase in physical capital each year then the increase in output per worker each year is calculated as follows:

= 10 × 0.25%

= 2.5%

Therefore, the estimated output per worker equal after one year:

= Initial output per worker + Increase in output per worker each year

= $1,000 + ($1,000 × 2.5%)

= $1,000 + $25

= $1,025

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