A closed economy can be described by the long-run classical model:

Y = 5K1/4L 3/4

C = 23500 + 0.6(Y - T) - 1200r

I = 15000 - 800r

MPK = 1.25K- 3/4L 3/4

MPL = 3.75K1/4L -1/4

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 labor are equal to 50625 and 10000 respectively. Initially, the level of government spending represents 24% of the initial national income. The government runs a budget deficit, and the size of the budget deficits is equal to 4% of total output.

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 3 decimal points if needed.

a) Compute the long-run equilibrium levels of consumption, national savings and real interest rate. Also, find the long-run equilibrium real wage for labor and real rental price of capital.

Suppose the outbreak of COVID-19 reduces spending by both households and businesses. As a result, autonomous consumption and autonomous investment change by 6% and 5% respectively.

b) Find the new long-run equilibrium levels of national savings and real interest rate, real wage, and real rental price of capital. (4 points)

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

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.

e) Suppose the government wants to promote the level of national savings to 8250 via a change government spending. Find the change in the level of government spending that will accomplish this goal. What happens to the budget balance (i.e., improves/deteriorates/no change)?