A closed economy

Question 2 (25 points) - Chapter 3 A closed economy can be described by the long-run classical model: Y = 4Kla‘3L2f‘3 C = 6440 + 0.8(Y - T) - 80or I = 3000 - 20or MPK = K* 2”L”3 MPL = K“3L”“3 In this economy, there are two productive factors, K and L and both factor inputs are fully employed. The stock of capital and the supply of labour are equal to 8000 and 3375 respectively. Initially, the government collects one-tenth of the long-run level of output from households as taxes and it runs a budget surplus of 200. Note: r represents the real interest rate and is measured in percentage points (for example, if r = 10, then this is interpreted as r = 10%). Keep your answers to 4 decimal points if needed. a) Compute the long-run equilibrium levels of consumption, national savings and real interest rate. Also, find the long-run equilibrium real wage for labour and real rental price of capital. (5 points). a) According to the long-run classical model, what happens to the equilibrium levels of output, real interest rate, and investment in Canada after TransCanada made this announcement? What happens to the real wage in Canada? Explain your answer with the aid of TWQ diagrams one for the loanablc funds market and one for the labour market. (10 points) b) (Continued from part a) As time passes (i.e., in the very long run which will be 10-15 years from now), what happens to the stocks of productive inputs in Canada? How would this change in the stocks of productive inputs affect the equilibrium levels of output and real interest rate in Canada? What happens to the real wage in Canada? Explain, and support your answer by a new set of loanable funds market and one for the labour market diagrams (15 points) Question 4 (25 points) - Chapters 7 & ‘7 Consider an economy that is characterized by the Solow Model. The (aggregate) production function is given by: Y = I4K""‘L3M Note: Keep your answer to mm if needed. Be sure to show your work. In this economy, workers consume 85% of income and save the rest. The labour force is growing at 3.5% per year while the annual rate of capital depreciation is 7%. Initially, the economy is endowed with 2250 units of capital and 200 workers. a) Is the economy in its steady state? Yes/no, explain why or why not. If the economy is not in its steady state, explain what happens to the capital-labour ratio and output per worker in the economy during very long-run transition. (10 points)