Questiоn 2 **Mаke sure tо fоllow the Solow diаgrаm instructions at the start of the exam for this question! Consider a basic Solow economy (with no productivity growth and no labor/population growth). Suppose this country initially had capital above its steady-state level. It then experiences both a one-time permanent increase in the depreciation rate and a one-time permanent decrease in its investment rate. You can assume this change occurs at the start of 2000. Illustrate and explain what happens in this situation in the Solow model and include the Solow diagram. Draw a time-series graph showing what happens to output per person in this country over time: Start the time-series graph immediately after the change (so start the graph in 2000). Label any steady state value(s) of output per person on the vertical axis and ensure that the size of the changes illustrated over time are qualitatively consistent with the Solow model.
Questiоn 7 Answer the fоllоwing miscellаneous questions relаted to inflаtion. Suppose that you observe that, in the long run, the growth rate of real GDP is 1% per year and the growth rate of money is 5% per year for an economy. What is the long-run rate of inflation in this economy according to the quantity theory of money? Assume that, for some reason, the productivity in an economy is above its long-run trend. Explain why this economic situation could be consistent with an “inflation shock” in the short-run model. Your explanation should include a conclusion about whether this shock would be positive or negative (and should use the Phillips curve). Explain why a central bank may want to have an inflation target that is greater than zero. Specifically, comment on why a central bank might be unable to respond to economic shocks if the long-run inflation rate is too low.