Question

As an economy adjusts to a decrease in the saving rate, according to Solow model, we would expect output per worker

A to decrease at a permanently higher rate.

B to return to its original level.

C none of the other answers is correct.

D to increase at a permanently higher rate.

E to decrease at a constant rate and continue decreasing at that rate in the steady state.

For this question, assume that equilibrium output is determined in the ZZ-Y diagram. Further assume that policy makers' goals are: (1) to achieve balanced trade (i.e., NX = 0); and (2) to achieve the natural level of output, say Y_n. Now suppose that the initial level of equilibrium output is equal to Y_n (i.e., Y = Y_n) and that a trade deficit exists at this initial level of output. Which of the following policy actions would most likely enable the policy makers to achieve their two goals simultaneously?

A A decrease in taxes and increase in the real exchange rate.

B A decrease in government spending.

C Convince the country's trading partners to pursue policies that will cause an increase in foreign income.

D None of the other answers is correct.

E A decrease in the real exchange rate.

Answer 1

Q. 1) As an economy adjusts to a decrease in the saving rate, according to Solow model, we would expect output per worker:

Correct choice:

B) to return to its original level.

Explanation:

A decrease in the saving rate will cause investment to fall. Capital stock and growth begin to fall, but this effect is temporary. In the long run adjustment process, output per worker returns to its original level at the steady state. This is not a permanent shock.

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Q. 2)

For this question, assume that equilibrium output is determined in the ZZ-Y diagram. Further assume that policy makers' goals are: (1) to achieve balanced trade (i.e., NX = 0); and (2) to achieve the natural level of output, say Y_n. Now suppose that the initial level of equilibrium output is equal to Y_n (i.e., Y = Y_n) and that a trade deficit exists at this initial level of output. Which of the following policy actions would most likely enable the policy makers to achieve their two goals simultaneously?

Correct choice:

C) Convince the country's trading partners to pursue policies that will cause an increase in foreign income.

Explanation:

The policy makers need to conduct an operation that raises trade balance, but doesn't affect Y. An increase in foreign income will help in balancing out the current account deficit, but will not affect GDP directly. Thus it will help achieve the goal.

All other options that cause any change in government expenditures or exchange rates will affect GDP.