Question

4. Consider the Solow growth model. By what proportion does per capita output change in the long run in response to the following changes? Assume the usual production function: Y; = ĀK, L (a) (5 points) The investment rate decreases by 30% as a result of a tax increase. (b) (5 points) The population increases by 10%. (c) (5 points) The capital stock decreases by 20%. (d) (5 points) The depreciation rate increases by 5%.

Answer 1

Solow swan model is an neo- classical economic model of long run growth. It explain long run economic growth by looking at capital accumulation, labour or population growth and increase productivity commonly referred to as technological progress. It is an exogenous model.

Assumptions:-

1.population is constant

2.production function exhibit constant returns to scale ( cobb Douglas production function)

3.constant savings rate

4. Output is the function of Labour and capital (Q=f(L, K))

5. Variable capital output ratio.

6. Output growth rate over time will be constant

Convergence by the solow growth model in the long run shows decreasing marginal productivity of capital.

Answer:-

Here, Y_t =Ak^1/3L^2/3

A= efficiency parameter

K = capital

L= labour

Output is affected by change in capital and labour. That is variable capital output ratio. From these function we can conclude that decrease in capital stock by 20% have more impact on output than increase in 10% population. So answer for the above question is option C.