Consider ouf grapn of the basic Solow growth model. Fin LF equilibrium) steady s

Question

Consider ouf grapn of the basic Solow growth model. Fin LF equilibrium) steady state On the graph above: y represents real output (or income) per worker; y-FCE ) is the production function: is the capital stock per worker; s is the savings rate; is the rate of depreciation of capital; ' represents business investment (purchases of capital) per worker); 'LF' stands for Loanable Funds. (For purposed of intuition, think of capital as ‘machines.") If we started out with a capital (per worker) stock lower than the steady-state stock ( above), we would expect to see which of the following happen over time? O Positive growth rates while the capital stock stays less than ko* (on the graph above). O Negative growth rates while the capital stock increases. O Positive growth rates while the capital stock increases. O Positive growth rates while the capital stock decreases. O Negative growth rates while the capital stock decreases.

Explanation / Answer

If we started out with a capital (per worker) stock lower than the steady state (k*) then we would expect to see positive growth rates while the capital stock increases.

Because When the economy starts with too less capital stock per worker (lower than the steady state ) then the policymaker must raise the savings rate to reach to the steady state.

Initially, when saving rate increases , Consumption decareses , and investment increases. And it implies that investment > &k [where & is depreciation rate] . So, therefore, k increases , and because of this investment increases and therefore y (output per worker) increases. and so the consumption level increases.

Therefore, as k increases over time there will be positive economic growth.

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