2. Supply and demand in the neoclassical economy Consider an economy in which the consumption, investment and production functions are as follows. C = 90 + 0:7(Y - T) I = 250 - 20r

Economics of Global Business Problem Set 2 F(K;L) = AK^(1/2)L^(1/2) The capital and labor supply are equal to 100 each, A=10, G = 200 and T = 200. Compute the equilibrium values of output, overall labor income, consumption, public savings, national savings, investment, and the interest rate. Suppose now government spending decreases to G=100 (everything else stays the same). What happens to output, consumption, savings, investment and the interest rate? Compute the new values for these variables.