Download PDF by David Romer: Advanced Macroeconomics Solution Manual

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It remains equal to the k* on the old balanced growth path. In contrast, c, the rate at which households are consuming in units of effective labor, can jump at the time that the tax is introduced. This jump in c is not inconsistent with the consumptionsmoothing behavior implied by the household's optimization problem since the tax was unexpected and could not be prepared for. c  0 c A E ENEW k*NEW k  0 k* k In order for the economy to reach the new balanced growth path, it should be clear what must occur.

In the figure, the economy jumps from point E to a point such as A. Since the return to saving and accumulating capital is now lower than before, people switch away from saving and into consumption. After time 0, the economy will gradually move down the new saddle path until it eventually reaches the new balanced growth path at ENEW . (c) On the new balanced growth path at ENEW , the distortionary tax on investment income has caused the economy to have a lower level of capital per unit of effective labor as well as a lower level of consumption per unit of effective labor.

The equation describing the dynamics of the capital stock per unit of effective labor is now given by (2 ' ) k ( t )  f ( k ( t ))  c( t )  G ( t )  ( n  g) k ( t ) . The fact that the government is making purchases that do not add to the capital stock – it is assumed to be government consumption, not government investment – shifts down the k  0 locus. © 2012 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner.

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Advanced Macroeconomics Solution Manual by David Romer

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