MGEB06 Assignment 1 (FALL 2022) 1
MGEB06 – FALL 2022
Macroeconomic Theory and Policy
Assignment 1
Due: On (or before) Monday, October 24th 11pm
(Note: Assignments submitted after 11pm on October 24th WILL NOT BE accepted under ANY
circumstance.)

The table below should be the cover page of each question submitted for your assignment.
Group members: Student number

Instructions:
 You can submit an individual or group assignment. If you submit a group assignment, there
must be no more than FIVE students in your group (coming from any one of the sections of
MGEB06 this term) and you must submit ONE copy.

A PENALTY OF 10% OF THE TOTAL MARKS will be imposed if you FAIL TO DO THE
FOLLOWING: Submit the filled-in table as your cover page (for EACH answer uploaded)

 Label your graph(s); otherwise, marks will be subtracted.
 No credit will be given if you do not show your work (i.e., don’t simply say the answer is 3 write
down enough of the steps you used to arrive at this answer).
 Your answer should be structured in a way such that those that know little about economics
will have no difficulty understanding your argument/answer.
 DO NOT USE any notations that are not used in lectures. If you use your own notations and/or
abbreviations that are not being used in lectures, you will receive a grade of zero for that
question.

MGEB06 Assignment 1 (FALL 2022) 2
Question 5 (25 points) – Chapter 8
Consider an economy that is characterized by the Solow Model. The (aggregate) production function is
given by:
Y = 4K1/4(LxE)3/4

Note: Keep your answer to 4 decimal places if needed. Be sure to show your work.

In this economy, workers consume 90% of income and save the rest. The labour force is growing at 3%
per year while the annual rate of capital depreciation is 5%.

Initially, the economy is endowed with 4000 units of capital, 100 workers, E is 1.0 & constant, and there
is no government.
a) Solve for the steady state levels of capital, output & consumption (all in per worker terms) (3 marks)
b) Is the economy initially at its steady state? Yes/no, explain. If the economy is not in its steady state,
explain what happens to the capital-labour ratio and output per worker in the economy during very
long-run transition. (4 points)

The economy is in its steady state as described above (the steady state you solved for in part a).
Suppose we now introduce a government. The government levies a tax on the economy that collects 5%
of output.
c) After this tax is collected you can assume that these funds are gone and that no goods or services are
purchased with them, and no government employees are paid with this tax revenue. Determine the
impact the tax has on the steady state levels of capital per worker & consumption per worker. Sketch
a diagram showing the impact of this shock. Explain what impact the shock has on the level and
growth rate of the standard of living (as measured by output per worker) in steady state. (8 points)
d) Suppose instead, after the tax is collected, the government is able to use these funds to create and
implement plans that cause the growth rate of labour augmenting technological change to rise to 3%
per year. Determine the impact the tax has on the steady state levels of capital per effective worker,
output per effective worker & consumption per effective worker. Sketch a diagram showing the
impact of this shock. Explain what impact the shock has on the level and growth rate of the standard
of living (as measured by output per worker) in steady state. (10 points)