A closed economy can be described by the long-run classical model: Y = 2KαL1–α C =...

A closed economy can be described by the long-run classical model:

Y = 2K^αL^1–α

C = 18500 + 0.75(Y – T) – 800r

I(r) = 11000 – 1200r

Note: r represents the real interest rate and is measured in percentage points (for example, if we find r = 10, then r is interpreted as being equal to 10%). Keep your answer to 4 decimal places if needed.

Assume that there are two factors of production, capital (K) and labour (L), and that they are both fully employed. For this economy the supply of capital and labour are 27000 and 64000 respectively; and one-third of output goes to capital owner. Initially, the government collects 6% of the economy’s (long-run) output as (income) taxes, and the size of the budget deficit is 540.

Compute the long-run equilibrium levels of consumption, investment and private savings. Also, find the long-run equilibrium real wage for labour.
Suppose the newly elected government wants to set the equilibrium level of national savings to 9104 via a change in (income) taxes. Find the level of taxes that will achieve the goal. What happens to the level of private savings (i.e., does it change? By how much).

Now, return to the initial long-run equilibrium as shown in part (a). Suppose there is a downward adjustment in the stock market. As a result, autonomous consumption falls by 10%.

Why does autonomous consumption fall when there is a downward adjustment in the stock market? Explain in words
Find the new long-run equilibrium levels of consumption and private savings.
Use the diagram for the loanable funds market to show your findings in parts (a) and (d). Be sure to clearly identify the equilibrium to each part of the question in your diagrams. No written explanation is needed.

Solutions

Expert Solution

Rahul Sunny answered 8 months ago

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