Initially, the economy is in steady state. Suppose there is a change in tax policy such that the government reduces the sales tax rate. a) In the context of the long-run classical model, what happens to the long-run equilibrium levels of investment and real interest rate?

What happens to the real wage?

Explain and support your answer with TWO diagrams: one for the market for loanable funds and one for the labour market (only the first two diagrams will be graded). (15 points) b) According to the Solow Model, what happens to the steady-state capital-labour ratio? In the new steady state what happens to the growth rate of output per worker? Explain and support your answer with ONE appropriate diagram. Be sure to explain what happens to the variables of interest during transition to steady state. (10 points)