1.When the government subsidizes investment, such as with an investment tax credit, the subsidy often applies to only some types of investment. This question asks you to consider the effect of such a change. Suppose there are two types of investment in the economy: business investment and residential investment. In addition, suppose that the government institutes an investment tax credit that applies only to business investment.

2.How does this policy affect the demand curve for business investment? The demand curve for residential investment?

3.Draw the economy's supply and demand for loanable funds graph. How does this policy affect the supply of and demand for loans? What happens to the equilibrium interest rate?

4.Compare the old and the new equilibrium. How does this policy affect the total quantity of investment? The quantity of residential investment?

5.Consider an economy with a government controlled (exogenous) saving rate (s), exogenous population growth (n), a fixed depreciation rate (d), but no technical progress (g=0). Suppose this economy is at steady state and has a relatively low saving rate so that its steady state capital labor ratio is below its golden rule capital labor ratio.

Write down the fundamental equation of growth (capital accumulation equation), draw a graph of its major components to illustrate the concept of steady state. On your graph, show the golden rule capital labor ratio.

6.Fully explain the economic intuition behind thestabilityof steady state. Explain the adavantages of maintaining a capital labor ratio at the golden rule level.

7.Suppose the government increased the saving rate to ensure enough investment to maintain the golden rule capital labor ratio as a steady state. Using graphs and written explanation, describe thetransitionof the economy from its initial steady state to the golden rule with the new higher saving rate. What happens to consumption and income per person (in levels and growth rates) in thetransitionperiod and in the new steady state. Are the growth rates of consumption and income per worker different in the two steady states?

8.Why might a benevolent government choose not to implement such a policy?

1. In the general equilibrium model of chapter 3, Mankiw assumes that consumption is a function of disposable income alone: C = C(Y-T).Modifythe consumption function to make consumption depend on both after tax income and the real interest rate. Provide an explanation for why the real rate of interest might affect real consumption expenditures. Using your modified consumption function, find an expression for national savings, and illustrate graphically the supply and demand for loanable funds equilibrium condition. Show (and explain) the impact of an increase in taxes on: the real rate of interest, national savings, investment, and the government budget deficit.

2. The amount of education the typical person receives varies substantially among countries. Suppose you were to compare a country with a highly educated labor force and a country with a less educated labor force. Assume that the countries are otherwise the same: they have the same saving rate, depreciation rate, population growth rate, rate of technical progress, and they initially have the same sized labor forces. If both countries are in steady state, what would you predict for the following variables in each country? (Be sure to illustrate your answer graphically and explain your results):r

a) The rate of growth oftotalincome.

b) The rate of growth of incomeper worker.

c) The rate of growth of consumptionper worker.

d) The real rental price of capital?