a. Use table 1 to calculate the growth in the capital stock (%?K) for the US ove

Question

a. Use table 1 to calculate the growth in the capital stock (%?K) for the US over the years 1995- 2002. When the growth in the capital stock is very high, as it was in 1995-2002, how does this relate to investment?

b. In the period from 1991-1995, the US government ran many budget deficits. However, from 1995-2002, these budget deficits turned into budget surpluses for a brief period (can you believe it?!). Using a loanable funds market diagram, explain a possible link between the stated effects above and the high value of the capital stock growth you found in (a).

Sources of Growth Years Output Growth Total Factor Capital GrowthLabor Growth Productivity Growth ( l-a)%2L 1.0 1.4 1.4 1.2 1.2 1.7 1.3 1950-1960 1960-1970 1970-1980 1980-1990 1990-1999 1995-200.2 3.3 4.4 3.6 3.4 3.7 3.7 1.2 1.2 1.0 0.6 0.9 0.9 1.2 0.9 3.6 1.2 1.2 1948-2007 1948-1972 1972-1995 1995-2007 4.0 3.4 3.5 1.2 1.3 1.5 0.6 This table assumes that capital has a 30% share in production (-0.3) and labor has a 70% share ((1-q) " 0.7). This table is taken from Macroeconomics, Seventh Edition (2010), by N. Gregory Mankiw

Explanation / Answer

a.

For the year 1995 - 2002

= .3

% K = 1.7

% K = 1.7/ = 1.7/.3 = 5.667

Thus,

Growth in capital stock (% K) = 5.667

Growth in capital stock can only be high when there is a huge amount of investment as increase in investment leads to growth in capital stock.

b.

After the budget deficit, US government went on to stimulate the economy and reduced the interest rate. It created a bigger demand of loanable funds. Thus, it resulted in increased investment that led to high growth in capital stock.

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