A. Multiple Choice Questions.

1. Suppose that the economy has the following production function:Y/L = 8*(K/L)0.5. Further suppose thats = 0.2, gL = 0.3, and δ = 0.1.What is the value of the steady state capital-to-labor ratio?

a. 1
b. 4
c. 8
d. 9
e. 16

2. In equilibrium, the rate of growth of the capital stock in a closed economy is primarily determined by:

a. The saving rate.
b. The growth rate of savings.
c. The growth rate of actual investment.
d. The growth rate of balanced investment.
e. The level of saving relative to balanced investment.

3. Suppose the government passes a law requiring households to increase their saving rate by 10%. According to the Solow Growth Model, in the short run:

a. Output per worker remains constant
b. Output per worker grows more slowly
c. Output per worker grows more rapidly
d. Output per worker grows at the same rate as the labor force
e. None of the above.

4. According to the Solow Growth Model, less-developed countries that have access to the latest productivities must be suffering from a relative shortage of _____, implying a very _____ rate of return available on additions to capital in those countries.

a. labor; low
b. labor; high
c. capital; low
d. capital; high

5. Supposethat both Country A and Country B have the same production function: Y/L = 6*(K/L)0.5. However, Country A has a capital-to-labor ratio that is initially twice as big as Country B. In addition, Country A has a 10% saving rate, a 10% labor force growth rate and a 5% depreciation rate while Country B has a 20% saving rate, a 10% labor force growth rate and a 20% depreciation rate.

a. The steady state capital-to-labor ratio in Country A is _____.

b. The steady state capital-to-labor ratio in Country B is _____.

c. Steady state output-per-worker in Country A is _____.

d. Steady state output-per-worker in Country B is _____.

B. Analytical Question.Answer the following question based on the standard models of analysis developed in class. The information in the various parts of the question is sequential and cumulative. Be sure to show and discuss each individual effect and not just the net effect of the exogenous shocks.

1. The Solow Growth Model.Suppose that a small open economy with perfect capital mobility and a current account deficit can be described by the Solow Growth Model and is initially at its steady state.

a. Based only on this information use a Solow Growth Model diagram to clearly and accurately show the economy's initiallevels of (1)economic output-per-worker, (2) investment-per-worker, (3) balanced investment-per-worker, and (4) the capital-to-labor ratio. This diagram should be drawn in BLACK.

b. Provide an economic explanation of what you have shown in your diagram above

c. Now suppose that a highly contagious disease quickly kills one-quarter of the labor force; then the diseasecompletely disappears. Incorporating only this additional information, clearly and accurately show in your diagram above what effects this would have on(1) economic output-per-worker, (2) investment-per-worker, (3) balanced investment-per-worker, and (4) the capital-to-labor ratio. These effects should be drawn in RED.

d. Provide an economic explanation of what you have shown in your diagram above. Discuss what happens to (1) economic output-per-worker, (2) investment-per-worker, (3) balanced investment-per-worker, and (4) the capital-to-labor ratio. Be sure to explain why these changes take place.

e. In response to these deaths the government undertakes a significant fiscal expansion to provide better housing for the surviving population. Incorporating only this additional information, clearly and accurately show in your diagram above what effects this would have onsteady state (1) economic output-per-worker, (2) investment-per-worker, (3) balanced investment-per-worker, and (4) the capital-to-labor ratio. These effects should be drawn in BLUE.

f. Provide an economic explanation of what you have shown in your diagram above. Discuss what happens tosteady state (1) economic output-per-worker, (2) investment-per-worker, (3) balanced investment-per-worker, and (4) the capital-to-labor ratio. Be sure to explain why these changes take place.

g. Discuss the adjustment process that occurs during the transition period from the economy's post-disease situation (i.e., part c) to its final steady state (i.e., part e). This discussion should include what happens to (1) economic output-per-worker, (2) the capital-to-labor ratio, (3) the rate of economic growth during the transition period, (4) the rate of economic growth once the final steady state is achieved, and (5) how the economy's long-run economic growth rate has changed.