Section 2: Short Answer. Answer each question completely. Watch out for question

Question

Section 2: Short Answer. Answer each question completely. Watch out for questions with multiple parts. Each question is worth 5 points. 1. Harrod-Domar Model Kt+1 = (1-5)Kt + It a. Using the equations above, derive the generic formula for growth in the Harrod- Domar economy. Show your work for full credit. Given the assumptions of the model, what must be true about the growth of the capital stock relative to the growth in output? Suppose that two countries differ in their savings rates. If country A has a savings rate of 20% and country B has a savings rate of 10%, which country will grow faster according to the Harrod-Domar Model? b. C. Suppose that nwo countries differ in tsavings rates I country A has a savings c.

Explanation / Answer

1 a.It is given that cYt = Kt, Kt+1 = (1-a)Kt + It, St=It and St = sYt

So It = sYt and Kt+1=cYt+1

cYt+1 = (1-a)cYt + sYt

dividing both sides by c we get Yt+1 = (1-a)Yt + sYt/c

Now Yt+1- Yt = sYt/c - aYt

Dividing both sides by Yt we get (Yt+1- Yt)/Yt = s/c - a = g which is the growth rate

b) The assumption is that capital - output ratio should be constant i.e. constant return to factor

c) as g = s/c-a so higher and s = saving / output so we see that higher the saving, higher will be the growth. So country A will grow faster than country B due t its higher saving rate

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