Question

Use the graph of the Solow growth model to explain what will happen to steady state y* and k* when a country experiences a natural disaster and sees population decline. Also use the function of k* to interpret the change when depreciation rate decreased.

Answer 1

(8+nk Investment, break-even investment (8+nk there is a decrease in the population growth rate. This is expected to reduce the steady state levels of capital per worker and output per worker. Fall in population growth rate from n, to n, is likely to shift the (8+nk curve upwards. At the beginning, depreciation is less than investment, implies capital is wearing out slower than sfck) capital accumulation. This will result in raising the capital k* k. * Capital per worker, k per worker till a new steady state capital per worker is determined. Hence, regions with a lower population growth rate have higher level of steady state capital per worker (k*) and a higher real GDP per person (y*) The steady state

(8, +n)k Economy is initially in the equilibrium. There is a decline in the rate of capital depreciation. Investment, Hence the economy will experience a shift in the break-even break-even investment curve downwards. At the tment curve downwards At the investment current level of capital per worker, depreciation falls short of the investment. At the initial steady state k *, rate of capital formation is more than the rate of its wear and tear. (8, +n)k fk Hence capital stock will rise and continue to rise till the economy reaches a higher value of steady state. Hence, capital stock in the steady state rises from k * tok, * and there is an increase in investment as shown by a movement from yellow bubble to green bubble. k* k* Capital per worker, k The steady state