Consider the One-Period Model.
Suppose that the production function that the rm operates is now given by
Y = z(G)F(K;N^d); with z(G) = (z + aG);
where z > 0, a > 0, and G > 0 is government spending.
Notice that in this framework government spending makes firms more productive (for
For example, government expenditures on roads and bridges lower the cost of transportation).
The budget constraint for the government is G = T, where T is lump-sum taxes.
1. Suppose that the government decides to increase G. Using a diagram, determine the
equilibrium effects of this shock on aggregate output, consumption, employment, and
the real wage. Show that increasing G can potentially increase welfare.
2. Compare your results with the case of unproductive government spending studied in
class (i.e., when a = 0).
Consider the One-Period Model.
Suppose that the production function that the rm operates is now given by
Y = z(G)F(K;N^d); with z(G) = (z + aG);
where z > 0, a > 0, and G > 0 is government spending.
Notice that in this framework government spending makes firms more productive (for
For example, government expenditures on roads and bridges lower the cost of transportation).
The budget constraint for the government is G = T, where T is lump-sum taxes.
1. Suppose that the government decides to increase G. Using a diagram, determine the
equilibrium effects of this shock on aggregate output, consumption, employment, and
the real wage. Show that increasing G can potentially increase welfare.
2. Compare your results with the case of unproductive government spending studied in
class (i.e., when a = 0).
