Question

Q.3    

Population growth in a country has increased. The higher population growth will lead to higher living standards. Comment on this statement with the help of a graph derived from the neoclassical growth model.                        

Assuming that the current crisis causes a decrease in the savings rate permanently.

In a neoclassical growth model, does this affects the growth rate of real output? Why or why not?                                

Answer 1

The neoclassical growth theory was developed by Solow and Swan, also known as Solow-Sawan model. it says that the growth of an economy depends on the three factors: technology, labor and capital.

The equilibrium or steady state in this model is attained through the interaction of curves which show saving(investment) per worker and depriciation per worker.

Now if the population has increased. This has a negative effect on capital per worker. Thus, the level of steady state equilibrium level of income for an economy will decline. This implies that the living standards will decline in an economy. Thus, the given statement that population growth leads to higher living standards is not correct according to the neoclassical growth model.

Now, let us talk about the permanent decrease in the saving rate. This permanent decline will lead to the downward shift of the saving or investment per worker curve and thus reduce the level of steady state equilibrium level of income. This is so because when saving per worker will decline permanently, the investment per worker is bound to fall because it is the savings that ultimately gets converted into investment. Due to this, the growth rate of real output is negatively affeced in the economy. In simple terms, savings decline, investment decline and ultimately this lowers the growth rate of real output.