1)Suppose we are at steady state in the Solow Model. Suddenly we have a significant technological advance.
(a) Show, using properly labeled graph(s), how this improvement in technology affects the steady state levels of income per worker, consumption per worker, and the capital-labor ratio.
(b) Does steady state income per worker increase, decrease, or stay the same?
(c) Does steady state consumption per worker increase, decrease, or stay the same?
(d) Does the steady state capital-labor ratio increase, decrease, or stay the same?
(e) Do any of your answers depend on what you assume about the golden rule capital-labor ratio? Why or why not?
#2)Suppose the Fed has just learned that a massive computer virus has attacked computers in the U.S. While productivity this quarter is unaffected, fixing the computers will take time (but at no cost) and will reduce the future marginal productive capital. Assuming no other changes in the economy, what would you (as member of the Federal Open Market Committee) do in response to the shock if you want to keep the economy at full-employment equilibrium under each of the following cases? Draw the movements in a IS-LM-FE diagram for each case, and explain your recommendation and reasons in words. Be sure to label your graphs carefully.
(a) You use the classical (RBC) model
(b) You use the Keynesian (efficiency wage) model
(c) You use the extended classical model with misperceptions, both with and without the shock being anticipated