Question

Read the article “The poor and the rich” from The Economist and answer the following questions.

1. Why is it that in the Solow neoclassical growth model “as the stock of capital expands, growth slows, and eventually halts”? Explain.

2. What does the empirical evidence tell us about the effect of Government policies on economic growth? Give some examples of how, according to the article, different Government choices have different implications for economic growth.

3. What are possible explanations for the extraordinary economic growth experienced by some East Asian Countries?

4. What conclusions can you draw from the article about what developing country should do to experience faster economic growth?

Answer 1

a).

Consider the given problem here the production function is given by, “y=A*f(k)”, where “y=output per worker” and “k=capital stock per worker”. Now, “s” be the savings rate, “d” be the rate of depreciation and the “n” be the population growth.

=> the change in the “k” is given by, “dk=s*y-(n+d)*k”, => at the steady state equilibrium “dk=0”, => “s*y = (n+d)*k”. Consider the following fig.

So, here “sy=investment per worker” and the equilibrium is at “E” where “sy” and “(n+k)*k” intersect to each other, => dk=0. So, here the steady state level of “k” is “k*”.

b).

Let’s assume that “sg” be the golden rule level of savings rate, => if the savings rate increase to “sg”, => the level of capital stock as well as the “c” both increases. Consider the following fig.

So, here initially “E1” be the equilibrium here the stock “k” is “k*” and the level of “c” is “c1*”. Now, as the savings rate increases to “sg*”, => the new equilibrium will “Eg”, => the level of “k” and “c” both increases to “k*g” and “c*g” respectively.

c).

As we know that there are direct relationship between “k” and “y”, => as “s” increases implied “k” increases implied “y” increase. Now, at the steady state equilibrium “k” is fixed, => “y” is fixed, => once the economy will reached there “k” and “y” will be fixed. So, at the steady state equilibrium the growth of “y” is ‘zero” but “Y”=output” will increase at the rate “n=population growth”.

Now, may be the growth of “y” is “0” but during the period of adjustment the growth of “y” is positive, => initially at “E1” the growth of “y” was “0”. Now, as the savings rate increases the “dk > 0”, => “k” start increasing and “y” also starts increasing, => the growth of “y” is positive. Now, once it get to steady state level of equilibrium, => the growth of become zero.

d).

Now, let’s assume that the savings rate is more than “sg”, => the initially level of “k” is more than “k*g” and “c” is less than “c*g”. Now, as the savings rate decreases to “sg” the level of “k” decreases to “k*” and the “c” increases to “c*1”.