The ultimate effect of the abolition of the subsidy is to increase the relative price of investment goods and to shift the K 0 line up and to the left. In the long run the economy ends up at point E 1 , with a lower capital stock and a higher value of q (due to the higher steady-state marginal product of capital). Since the discrete adjustment in q must occur at the time of the announcement tA, and the economy must be on the new saddle path at the time of implementation t1, the adjustment path must look like the one sketched in the diagram. At tA there is a financial correction that pushes the economy from 93 Ka K K

B q A sI B

to ti q

sI time The Foundation of Modern Macroeconomics to A directly aim

= ec( n-.

az