Suppose that the U.S. enacts a tax policy that encourages saving behavior. The policy increases the saving rate immediately and permanently from to . Assume that the U.S. economy starts in its initial steady state.

i) Analyze this change using the Solow diagram. What happens to the economy over time?

ii) Explain what happens to investment, consumption and output during the transition and in the long-run. Be specific.

iii) How does the saving rate generate growth in the Solow Model? Why does it fail to deliver economic growth in the long run?