Consider Solow's model when the production function is Y = 1000K0.3 L0.7 . The population growth rate is 2%, ? = 0.1 is the depreciation rate and s = 0.25 is the savings rate. Suppose this economy was in its steady state when unexpectedly Total Factor Productivity increases by 10%.
a) Compute how much more output there is in this economy immediately thanks to this improvement in technology.
b) Assume that the economy has made the transition towards its new steady state. Perform a growth accounting exercise: given the initial and the final steady states, compute how much of growth per unit of labor is accounted for by the increase in capital per unit of labor and how much is accounted for by the technological improvement.
c) Discuss to what extent the result of this accounting exercise is correct. Remember that the savings rate did not change at all.