Suppose we started out at the steady state capital stock in the basic Solow grow

Question

Suppose we started out at the steady state capital stock in the basic Solow growth model. If there subsequently were a decrease in the supply of loanable funds due to less favorable tax treatment of individual interest income, then we would expect to see economic growth rates turn negative as we move toward the new steady state and the nation's capital stock to decrease from its current level o economic growth rates turn positive as we move toward the new steady state and the nation's capital stock to decrease from its current level. o economic growth turn negative as we move toward the new steady state and the nation's capital stock to grow from its current level. o O economic growth rates stay the same and the nation's capital stock to grow from its current level. Suppose we started out at the steady state capital stock in the basic Solow growth model. If there subsequently were a decrease in the supply of loanable funds due to less favorable tax treatment of individual interest income, then we would expect to see O

Explanation / Answer

Correct option is (1).

A fall in investment demand in loanable funds market will decrease the future capital stock This causes the economy to move toward a new steady state equilibrium in which economic growth is lower.

Economic growth rate = Original steady state growth rate - Rate of decrease in new capital investment

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