A closed economy can be described by the long-run classical model: Y = 8K^1/3L^2/3 C = 7000 + 0.75(Y T) 1000r I = 25000 800r K and L (two productive factors) and both factor inputs are fully employed. The stock of capital and the supply of labour are equal to 27000 and 8000 respectively. Initially, the government collects 15% of the long-run level of output from households as taxes and it runs a budget deficit of 1000. r represents the real interest rate and is measured in % (i.e. if r = 10, then r = 10%). Keep your answers to 4 decimal points if needed. a) Compute the LR equilibrium levels of private savings, investment, and real interest rate. Also, find the long-run equilibrium real wage for labour and real rental price of capital. Recently, the economy experienced a major boost in the mood of the country due to celebrations of the fiftieth birthday of the prime minister. The birthday celebrations result in an increase in both consumer and business confidence. Autonomous consumption, and autonomous investment change by 7% and 20% respectively.

b) Find the new LR equilibrium levels of private savings, investment, and real interest rate.

c) Compare answers in parts (a) & (b), what happens to private savings (i.e., increase/decrease/remain unchanged)? Explain, in words only, why the variable changes or remains unchanged.

d) Show your answers for (a) & (b) in three diagrams (that depict the loanable funds market, the labour market, and the rental market for capital in long-run equilibrium). Be sure to identify which points on your diagrams are the long-run equilibria for part (a) & (b) respectively. No written explanation is required.

e) Suppose the government wants to target the LR level of real interest rate so that it remains at its initial LR level (from part b). Is this possible and if so, determine the change in the level of government spending that will achieve the goal.