Solow growth model: steady state. What does it mean for the economy to be in the...

Solow growth model: steady state. What does it mean for the economy to be in the steady state? How is the steady state determined? How does steady-state output per person depend upon the investment and depreciation rates? Explain why an increase in the investment rate raises steady-state y. What are the effects of a rise in TFP or a fall in the rate of depreciation on steady-state y?

Expert Solution

In the Solow model, it is assumed that all the economies tend to move towards the steady state level of output. In the steady state level of output, investment is equal to depriciation. This is why all the investment is being used just to repair and replace the existing capital and no new capital is being created.

At the steady state level of output,

sy = (n+d)k.

Where sy = saving per worker.

n= number of workers

d= depriciation

K= capital per worker

This says that steady state is reached where savings per worker is exactly equal to the level of investment required to maintain the existing capital.

The increase in investment rate rises the steady state level of output because increase in investment raises the capital stock of the economy due to which the steady state level rises.

A rise in total factor productivity will result in more capital with the existing stock of inputs(labor and capital). This implies rise in steady state.

Fall in the rate of depriciation also implies that the capital stock per person rises thus increasing the level of steady state of output.

Rahul Sunny answered 6 months ago

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