Question
A closed economy can be described by the long-run classical model: Y = 4K1/3L2/3 C = 5000 + 0.75(Y - T) - 700r I =
A closed economy can be described by the long-run classical model: Y = 4K1/3L2/3 C = 5000 + 0.75(Y - T) - 700r I = 22200 - 1100r In this economy, there are two productive factors, K and L 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 fifteen percent of the long-run level of output from households as taxes and it runs a budget deficit of 1000. Note: r represents the real interest rate and is measured in percentage points (for example, if r = 10, then this is interpreted as r = 10%). Keep your answers to 4 decimal points if needed. a) Compute the long-run 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. (5 points). Suppose a pandemic sweeps the country. Sadly 10% of the country's population and workforce die as a result. b) Find the new long-run equilibrium levels of consumption, investment, and real interest rate. (3 points). c) Compare your answers in parts (a) & (b), what happens to output per worker and the real rental prices of labour and capital (i.e., increase/decrease/remain unchanged)? Explain, in words only, the economic reasons why the variable changes or remains unchanged. (6 points) d) Show your answers for parts (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. (6 points)
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