Learning Activity # 1

Question 1

In the Mundell-Fleming model with fixed exchange rates, what happens to aggregate income, the exchange rate, and the trade balance when government increases spending or reduce taxes. What would be the result if the exchange rate is floating?

Question 2

Assume production function is given by:

Y= K^(1/2) L^(1/2)

a. Write the production function in per worker terms (y=f(k))

b. Assume that the per worker level of capital in the steady state is 4, the depreciation rate is 5% per year, and population growth is 5% per year. Does this economy have "too much" or "too little" capital? How do you know? [Show your work].

Question 3

Consider an economy described by the production function:

Y = F(K, L) = K^0.3 L^0.7

a. What is the per-worker production function?

b. Assuming no population growth or technological progress, find the steady-state capital stock per worker, output per worker, and consumption per worker as a function of the saving rate and the depreciation rate.

c. Assume that the depreciation rate is 10 percent per year. Make a table showing steady state capital per worker, output per worker, and consumption per worker for saving rates of 0 percent, 10 percent, 20 percent, 30 percent, and so on. (You will need a calculator with an exponent key for this.) What saving rate maximizes output per worker? What saving rate maximizes consumption per worker?

Question 4

The initial steady-state level of capital per worker in Tobago is 5 while the Golden Rule level of capital per worker is 8.

a. Discuss what must change in Tobago to achieve the Golden Rule steady state?

b. Why might the Golden Rule steady state be preferred to the initial steady state?

c. How does population growth change the Solow Growth Model?

d. Does technological progress enhance the Solow Growth Model? If so, in what ways.