Question

The economy is initially in its long-run equilibrium. The outbreak of the pandemic has increased the speed of autonomation and artificial intelligence (AI); as a result, the spending on autonomation and AI increases by 10%. a) According to the long-run classical model, what happens to the equilibrium levels of output, real interest rate, and investment? What happens to the real wage and the real rental price of capital? Explain your answer with the aid of THREE diagrams – one for the loanable funds market, one for the labour market, and one for the rental market for capital. (15 points)

b) (Continued from part a) What happens to the stock of the capital in the very long run? Use the longrun classical model to examine the effects on output and real interest rate in the very long run. What happens to the real wage and the real rental price of capital? Explain your answer with the aid of another set of THREE diagrams – one for the loanable funds market, one for the labour market, and one for the rental market for capital. (15 points)

c) Use the Solow to explain the impact of this shock on the steady state level of output per worker and consumption per worker. Use one Solow model diagram to demonstrate your answer, don’t forget to clearly label the initial and new steady state points.

How do I do part C??

Answer 1

The ongoing pandemic has increased the speed of automation and artifical intelligence which can be implied as a positive shock to the technological process of the economy.

Let us assume the production function

  ^where   

^{where A is the technolgical progress , K in the capital and L is labour.}

^{and represnts the rate of depreciation. (Assuming the population growth as n= 0)}

^{Dividing both sides by L gives us the following equation,}

^{,    is the rate of depreciation per worker and is the savings per worker at initial level .}

^{After incorporating the technological process the equation ( i.e the level of A increases to a new level ) , the equations becomes where}

As we can see from the above figure, at initial level of technology A', the steady state per worker is k'* and income per worker is y'* . With an increase in A, from A' to A'',  the production function shifts upwards due to technological advancement , leading to increase in the steady state per worker as well. This increase also shifts the savings/investment curve upwards. It is important to note that the savings rate has not increased, the shift in the curve comes from increase in the output per worker.This results in an increase in the steady state level of output per worker by moving from y'* to y"* . As the output per worker increases, the consumption per worker also increases . Hence an increase in technological parameter A leads to an increase in output per worker and consumption per worker as well.