Suppose that the economy is initially in a steady state and that some of the nat

Question

Suppose that the economy is initially in a steady state and that some of the nation’s capital stock is destroyed because of a natural disaster or a war.

(a) Determine the long-run effects of this on the quantity of capital per worker and on output per worker.

(b) In the short run, does aggregate output grow at a rate higher or lower than the growth rate of the labor force?

(c) After World War II, growth in real GDP in Germany and Japan was very high. How do your results in parts (a) and (b) shed light on this historical experience?

Explanation / Answer

(a) The long-run equilibrium is not changed by an alteration of the initial conditions. If the economy started in a steady state, the economy will return to the same steady state. If the economy were initially below the steady state, the approach to the steady state will be delayed by the loss of capital.

(b) Initially, the growth rate of the capital stock will exceed the growth rate of the labour force. The faster growth rate in capital continues until the steady state is reached.

(c) Germany and Japan grew much faster than other countries because there economy is destroyed because of world war II

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