Question

. Suppose we started out at the steady state capital stock in the basic Solow growth model. If the government increased the budget deficit (ceteris paribus) with no effect on the demand for loanable funds from private businesses, then we would expect to see what effects on

a. the nation’s capital stock as we move from the original steady state to the new one (and output per worker, y).

Answer 1

The Solow Growth Model is an economic model of long run eceonomic growth set within the framework of neoclassical economics. It attempots to explain long -run economic growth by looking at capital accumulation, labour or population growth and increases in productivity, commonly referred to as technological progress.

Slolving tghe Solow Growth Model.

1. The income-expenditure identity holds as an equilibrium condition: Y = C + 1

2. Consumer's budget constraint: Y = C + S

3. Therefore, in equilibrium: 1 = S = sY.

Robert Solow and Trevor Swan first introduced the neoclassical growth theory in 1956. The theory states that economic growth is the result of three factors: Labour, Capital and Technology. While an economy has limited resources in terms of capital and labour, the contribution from technologyh to growth is boundless.

Solow builts his model around the following assumptions:

1. One composite commodity is produced.

Output is regarded as net output after making allowance for the depreciation of capital

3 There are constant returns to scale. In other words, the production function is homogeneous of the first degree.

Government Budget Deficit

Government Budget Deficit can reduce national saving and crowd out investment. It is worth noting that the Solow model says that higher saving leads to faster growth in the Solow model, ut only tgemporarily. As increase in the rate of saving raises growth only until the economyreaches the new steady state.

The Solow growth model focuses on long run economic growth. A key component of economic growth is saving and investment. An increase in saving and investment raises the capital stock and thus raises the full employment national income and product.

We may now discuss how poulation growth, along with investment and depreciation, influences the accumulation of capital per worker. In the basic Solow model, while investment increases capital stock, depreciation reduces it. In this edtended model, another factor changes the amount of capital per worker: the growth in the number of workers causes capial per worker to fall.