How decrease in labor will influence on steady state level of capital and output in Solow...

How decrease in labor will influence on steady state level of capital and output in Solow model.Show on diagram

Expert Solution

It shall be noted that the production function in the Solow growth model is Y = f(K,L), or expressed in terms of output per worker, y = f(k).

If the labor force decreases, the L falls but Capital-labor ratio k = K/L rises.

The production function tells us that total output falls because there are fewer workers.

Output per worker increases, however, since each worker has more capital

The reduction in the labor force means that the capital stock per worker is higher.

Therefore, if the economy were in a steady state prior to the fall in labor, then after the fall in labor, the economy has a capital stock that is higher than the steady-state level.

This is shown in the figure below as an increase in capital per worker from k1 to k2.

As the economy returns to the steady state, the capital stock per worker falls from k2 back to k1, so output per worker also falls.

Rahul Sunny answered 2 years ago

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