Reference no: EM133198505

Assignment:

Question 1. Consider an economy whose long-run behavior is described by the Solow model.

A. Suppose that a change in the tax laws causes the economy's saving rate (s) to permanently increase. Show graphically the steady state per-worker values of capital, investment and consumption both before and after the change in the saving rate. Briefly explain.

B. Suppose that instead of an increase in the saving rate, the economy experiences a permanent increase in the depreciation rate (d). Show graphically the steady state per-worker values of capital, investment and consumption both before and after the change in the depreciation rate. Briefly explain.

C. Suppose now that new computer technology makes business permanently more efficient. Show graphically the steady state per-worker values of capital, investment and consumption both before and after this change. Briefly explain.

D. Suppose that a storm destroys some of the economy's capital stock, but leaving the saving rate, productivity level, depreciation rate and population growth rate unchanged. Show graphically the steady state per-worker values of capital, investment and consumption both before and after this change. Briefly explain.

Question 2. Suppose that the President proposes to lower the tax rate on interest income, claiming that, "If we encourage people to save, the economy will grow more quickly." As a statement about the long-run behavior of the economy, would this claim be true in a world described by the Solow model? Could this claim be true in a world described by an endogenous growth model?

Question 3. Consider the two-period model of consumption behavior, with y₁ = 60, a₁ = 10, y₂ = 31.8 and r = 6%.

A. What is the present value of the consumer's lifetime resources (PVLR)?

B.  Suppose y₁ increase form 60 to 70. What is the consumer's PVLR now? Show graphically the effect of this change on consumption in both periods. Be sure to indicate by how much the budget line shifts.

C. Suppose y₂ increases from 31.8 to 47.7. (y₁ is at its original value of 60.) What is the consumer's PVLR now? Show graphically the effect of this change on consumption in both periods. Be sure to indicate by how much the budget line shifts.

D.  Which income increase, the one in part B or the one in part C, results in a bigger increase in current consumption (c₁)? Which one results in a bigger increase in future consumption (c₂)? Which one results in a bigger increase in saving (s = y₁ - c₁)? Briefly explain.

E. The one-period income increase described in part B could be considered a temporary income increase. Now suppose that income permanently increases by 10 units a period, so that y₁ increases form 60 to 70 and y₂ increases from 31.8 to 41.8. What is the consumer's PVLR now? Which income increase, the temporary one described in part B or the permanent one described here, results in a bigger increase in current consumption? Which one results in a bigger increase in future consumption? Which one results in a bigger increase in saving? Briefly explain.