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# Consider the Solow model with the following parameters/exogenous variables: ?̅, ?̅ , ?̅, ?̅, ?̅, and...

Consider the Solow model with the following parameters/exogenous variables: ?̅, ?̅ , ?̅, ?̅, ?̅, and ?0. In the standard model, we assume that each unit of investment can be converted into future capital one-for-one. Relative to the standard Solow model, in this exercise we include a new parameter to capture the “marginal efficiency of investment.” That is, we introduce the parameter ?̅ which reflects the rate that investment can be converted into future capital stock. This term shows up in the capital accumulation equation as ??+1 = (1 − ?̅)?? + ?̅?? .

a. Suppose the economy is in steady state in the initial period; that is, ?0 = ? ∗ . Suppose there is an increase in̅?. Plot the transition path (over time) for the rental rate of capital (MPK). Rental rate of capital on vertical axis, time on horizontal axis.

b. Suppose the economy is in steady state in the initial period; that is, ?0 = ? ∗ . Suppose there is an increase in̅?. Plot the transition path (over time) for consumption. Consumption on vertical axis, time on horizontal axis.

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