The 1990s IT boom. In the late 1990s in the US, large expected future improvements in information technology fueled an increase in investment demand. Because most of the benefit from such technologies were expected to accrue in the future, you may assume that current TFP did not change.

a. (6 pts.) Let us start by assuming that the US is a closed economy, that production is given by a Cobb-Douglas function, and that prices are flexible. Suppose that the real rental rate grew by 2% annually, the capital-to-labor ratio by 3% and that labor's share of income is 60%.

Based on this information, what is your best estimate of the growth rate of output per worker? Please carefully show your calculations. From a historical US perspective, would you say that this is a good growth rate of GDP per capita?

b.Continuing to assume that prices are flexible and the economy is closed, what is the short- term impact of this boom in investment demand on the US interest rate, savings, investment and GDP? Assume that savings depend positively on the real interest rate. Please include any graphs that you find useful.

c.In the very long run, also the capital stock is flexible. Please describe how you expect the economy to adjust to its very long run steady state. What happens to the rental rate of capital over time? What happens to the capital stock per worker?

d.Consider now instead the case in which the US is an open economy. For simplicity, you may assume that the US is small relative to the rest of the world. Prices are still assumed to be flexible.

What is the impact of the increase in investment demand on US savings, investment, net exports and output in the short-run? Is the long run effect of the IT boom on output larger or smaller than in the closed economy case? Please include any graphs you find useful.