1. Growth: What is the mechanism in the Solow Growth Model that generates growth
ID: 1141659 • Letter: 1
Question
1. Growth: What is the mechanism in the Solow Growth Model that generates growth? What is the advantage of this mechanism? Why does it eventually stop delivering economic growth? Explain your answers. (paragraph answer) 2. Consider a small island nation. Assume the economy is following the Solow Growth Model. Let K = $100 Billion dollars and L-100 million persons. The production function is Y K3/10 L710 Let savings rate = 10% and depreciation rate = 5% a. Is the production function a Cobb-Douglas function? Explain how you know. (short answer) b. Does the production function have diminishing marginal returns to capital? Explain how you know. (short answer) c. What is the production function for output per capita, y? (show your work) d. What is the steady-state value of capital per capita, k*? (show your work) e. What is steady-state value of output per capita, y (show your work) f. What is steady-state value of investment per capita, i? (show your work) g. What is the steady-state value of consumption per capita, ? (Show your work) 3. Earthquake: Assume an earthquake has occurred to the country in Question 3. Half of the capital is destroyed. Assume the other elements are unchanged a. What is the steady-state value of capital per capita, k ? (show your work) b. What is steady-state value of output per capita, y? (show your work) 4. Foreign Investment: Imagine the country in Question 3 did not suffer an earthquake (ignore Question #4). Instead, many foreign companies invested in the country. They added $100 Billion dollars to the capital. What is the steady-state value of k (called k), capital per capita? (show your work) a. What is the steady-state value of capital per capita, k ? (show your work) b. What is steady-state value of output per capita, y*? (show your work) 5. Analysis: Look at your answers for Question 3e, Question 4b, and Question 5b. What do all of the answers have in common? Why? Explain. (paragraph answer)Explanation / Answer
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Accumulation of capital is critical for generating economic growth. Increase in capital accumulation leads to the rise in the per capita availability of capital. When per capita availability of capital generates or increase per capita output. Thus, output gets generated.
But rise in capital accumulation cannot keep on increasing growth rate perpetually. Diminishing returns to capital ensues, now increase in capital stops adding output. Eventually, steady state reached, which occurs in long run.
As more capital is added, more depreciation also occurs. Hence, increase in capital or accumulation of capital is required to offset loss of depreciation.
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