Consider a numerical example. In the Solow model, assume that n = 0, s = 0.2, d = 0.1, and F(K,N) = K0.3 N0.7. Suppose that initially, in period t = 0, z = 1 and the economy is in a steady state.
(a) Determine consumption, investment, savings, and aggregate output in the initial steady state.
(b) Suppose that at t = 1, total factor productivity falls to z = 0.9 and then returns to z = 1 for periods t = 2, 3, 4, . . . . Calculate consumption, investment, savings, and aggregate output for each period t = 1, 2, 3, 4, . . . .
(c) Repeat part (b) for the case where, at t = 1, total factor productivity falls to z = 0.9 and then stays there forever.
(d) Discuss your results in parts (a)–(c).