Calculate the desired capital stock, Macroeconomics

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Suppose that the desired capital stock is given as:

K* = 0.3Y/ir

Where Y = GDP, and ir is the real interest rate.  Suppose further that Y = $5 trillion and that

ir  = 0.12 (12 percent).

a.  Calculate the desired capital stock, K*.

b.  Now suppose that Y rises to $6 trillion.  What is the corresponding (or new) desired capital stock?

c.  Suppose that the actual capital stock (K) was equal to the desired capital stock (K*) before the increase in income from $5 trillion to $6 trillion.  Assume that a gradual adjustment process of actual to desired capital occurs, such that λ = 0.4.  What will the level of investment be in the first year after the change in income?  What will investment be in the second year after the change in income?

 


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