Question

a). Empirical evidence suggests that poor countries do not have higher rates of return on capital. Explain why this evidence is at odds with the Solow growth model.

b).Using an appropriate diagram, explain the effect of an increase in the population growth rate on the steady-state income per person. Show and explain how the saving rate must change in order for a rise in the population growth rate to leave the steady-state unchanged. Explain your answer intuitively.

Answer 1

a)

Solow growth model says that when per capita availability of capital is increased, it causes rise in growth rate or output per workers. But such evidence has not been seen in developing countries, Thus, such results are not consistent with Solow growth model.

b)

Increase in population growth rate will cause fall in per capita availability of capital. Thus, Breakeven investment line would shift left.

Following is diagram:

Solow growth model and population growlh rete change*k tt-dlk (n*c)k yo y. sy Sy, Sy k, ko

In above diagram, when break even investment line shifts from (n+d)K to (n1 +d)K thereby reducing the per capita availability of capital from K0 to K1.

it reduces the per capita output or output per worker, further, saving rate also falls.

It can be corrected through the rise in saving rate. if the saving sY shifts upward, old equilibrium can be restored.