Exercise 2. An increase in the saving rate. (31 points) Consider an economy that follows the dynamic as in the Solow model developed in class, with constant L. Suppose a country enacts a tax policy that encourages investment, and the policy increases the investment rate immediately and permanently from S to 5'1 (with $1 > 5). Assuming the economy starts in its initial steady state, use the Solow model to explain what happens to the economy over time and in the long run. Suppose that the country begins in steady state (t:0). Assume that the increase in the parameter 5 occurs at period 3 0:3) and that this effect is permanent. Answer the following: a) (11 points) Analyze this change using a Solow diagram. What happens to the economy over time? 0 Here, I want you to Show the Saving and Depreciation curve, before and after the shock. b) (5 points) In the long run, what happens to output? c) (15 points) Show the transition dynamics. Draw a graph showing what happens to aggregate capital (K) over time. Do the same for output (Y) and Consumption (C). 0 You should have three different plots: i) Kt vs t, ii) Yt vs 1?, iii) Ct vs 1? (all starting at t:0)