Question

Let the Cobb-Douglas parameter alpha equal 0.3. Then in the Solow growth model steady-state consumption will surely be increased if (check all that apply):

A. The saving rate decreases from 0.50 to 0.25

B. The saving rate increases from 0.25 to 0.50

C.The saving rate increases from 0.25 to 0.30

D. The saving rate decreases from 0.35 to 0.30

Answer 1

Solution :

Alpha in the Cobb-Douglas indicates the percentage of capital used in the production process.

At the steady state,the investment is equal to the depreciation i.e., all the investment goes towards the repair and replacement of the existing capital.

So,D. is the answer

We know that any output earned can either be saved,consumed.In the steady state,the investment will be equal to the depreciation.But here it is given that % of capital used is 30% i.e., 0.3.

In the solow growth model steady state consumption will surely be increased of the savings rate decreases from 0.35 to 0.30.

If the savings rate falls below the 30 % mark,the solow model looses the steady state as the investment (which was saved and invested i.e., alpha reduces below 30%. but the depreciation remains the same.

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