Question

Neoclassical Growth, and the Piggy Bank

1. What would be the effect of a rise in the saving rate s on the steady state capital/labor ratio?

2. Draw a Solow diagram showing this effect.

3. What are the other effects of a change in the saving rate: growth rate, standard of living, interest rates and wage rates?

Answer 1

Part A

An increase in the saving rate has increased the level of capital-labor ratio. Then the economy moves to a higher steady-state capital-labor ratio. In the new steady-state level, the capital per worker and output worker is higher than that of the original steady-state level. The higher saving rate would lead to higher output, consumption and capital per worker in the long run. So the policymakers are always trying to improve the higher saving rate in the economy.

part B

In the diagram, the saving rate increased from S to S1. The corresponding point saving per worker to the steady state investment per worker moved from point A to B. on this the capital-labor ratio increased from k*1 to k*2.

Part C

Higher the saving rate the higher the consumption per worker in the long run.