Question

Question 1. Let us introduce government spending in the basic Solovv model. Consider the basic model without technological change and suppose that Hill = Cit} + it\" + Git). with H t] denoting production, C(t] denoting consumption, Git} denoting go- vernment spending at time t. Imagine that government spending is given by Git] = o'l'it}. {a} Discuss how the relationship between income and consumption should he changed. Is it reasonable to assume that Cit} = si'ftl. where s E ((1.1)? {h} Suppose that government spending partly comes out of private consump- tion, so that fit) = {5 holrit}, where it E [[1,1]. What is the e'ect of higher government spending [in the form of higher or} on the equilibrium of the Solotv model? {cl Now suppose that a fraction :1: of Git} is invested in the capital stocLso that total investment at time t is given by Ht} = i1 5 [l Filo + ups-Wit}. where Ht) denotes investment. Show that if ti: is sufciently:r high. the steadvstate level of capital-labor ratio 1will increase as a result of hig- her government spending {corresponding to higher tr}. is this reasonable? HOW would vou alternativelv introduce public investments in this model