Question 1:

According to the Solow growth model, how would each of the following developments affect output per worker and consumption per worker in the long run (that is in steady state)? Explain.

(a) The destruction of a portion of the nation's capital stock in a war.

(b) A permanent increase in the rate of immigration from a country where religion forbids birth control. Hint: map this experiment into discussion of the effect of a change in the growth rate of the population on growth.

(c) Consumers become permanently more concerned about the future and decide to consume a smaller portion of their income.

Question 2:

The country of West Ink produces regular ballpoint pens that are sold for 10 oros each. (The currency in West Ink is called the "oro".) The country of East Ink makes deluxe pens that are sold for 150 crowns each. (The currency in East Ink is called the "crown".)

The real exchange rate between West and East Ink is two regular pens per deluxe pen.

(a) What is the nominal exchange rate between the two countries? Hint: use the formula we discussed in class that relates the real and the nominal exchange rate.

(b) During one year West Ink has 10% domestic inflation and East Ink has 20% domestic inflation. Two ordinary pens are still traded for one deluxe pen. At the end of the year what has happened to the nominal exchange rate? Which country has had a nominal appreciation? Which country has had a nominal depreciation?