The benchmark (initial) economy is one where the fraction of healthy people is constant and
equal to one: ht = 1 for all t. Please note that per capita variables are always in terms of total
population (yt =
Yt
N
, and so on). For simplicity assume s = delta .
a) Suppose that at time t = 0 the economy is at the benchmark steady-state. Then, at t = 1
the fraction ht permanently decreases as a result of a new dangerous virus. In particular, we
have h
′
t = 0.85. Explain how this permanent change affects the economy both in the shortrun (on impact and throughout the transition) and in the long run. Specifically, show (with
pictures!) what happens with capital, output, investment and consumption over time (in per
capita terms!).