Homework 4-

1. Consider the Solow growth model with population growth where labor's share of output is ¾, the savings rate is 15%, the depreciation rate is 7%, and the population growth rate is 3%.

a. Find the steady state level of capital per worker and output per worker. (There are exponents involved. Do not use your calculator to reduce them.)

b. What is total labor income in the steady state?

c. Using the model discuss how the steady state level of capital per worker and output per worker would change for increases in the savings rate, the depreciation rate, population growth rate, or labor's share of income.

2. Using the model of aggregate demand discuss the effects of monetary policy on the price level and output. (At the minimum you should address movements of the aggregate demand curve, the adjustment process, and the differences between the long run and short run aggregate supply curves. Drawing graphs should help in the exposition.) 

3. Make the following assumptions:

C = a + b(Y - T )

I = c + d(r)

L(i , Y) = g + f( i ) + eY

Closed economy

a. What limitations should be placed on b and d?

b. Derive a functional form for the IS curve.

c. How does the IS curve 'move' for a change in T, G, a, b, and d?

d. If the LM curve does not depend upon the real interest rate how does Y change for a given change in T, G, a, and c?

e. Derive a functional form for the LM curve.

f. What limitations should be placed on f and e?

g. How does the LM curve 'move' for a change in M, P, g, f, inflation, and n? (Note that M is the money supply, P is the price level, and i is the nominal interest rate.)

h. Derive the aggregate demand by equating the IS and LM curves.

4. Using the aggregate demand curve derived above discuss the following assuming the aggregate supply curve is horizontal.

a. What effects does raising taxes have on output?

b. What effect does decreasing government spending have on output?

c. If the country was running a deficit would you recommend increasing taxes or decreasing government spending to balance the budget?

d. If the government wanted to spur the economy forward would you suggest a tax cut policy or an increase in government spending? (The budget does not need to be balanced.)

5.   Again, record the price of the basket of goods you selected in the previous  homework. Calculate a CPI like figure for this period with the first measurement period being the base period.