Question

Consider the standard Solow model with population growth and technological progress. Suppose we introduce a government that imposes a lump-sum tax on all individuals

a. Write down the new steady state equation for this economy. b. Would the steady state capital stock be higher or lower as a result of the lump-sum tax? Explain. Illustrate this tax. c. Explain how this tax affects the golden rule level of per capita capital stock.

b. Would the steady state capital stock be higher or lower as a result of the lump-sum tax? Explain. Illustrate this tax.

c. Explain how this tax affects the golden rule level of per capita capital stock.

Answer 1

Answer (a): Under the Standard Solow model with population growth and technological progress, if the Government imposes a lump-sum tax on all the individuals, then the new steady state equation for the economy would be:

                                          Y (t) = AF (K (t), N (t))

                                  Here, the steady state equation represents the level of progress in the production function in the economy at the level of current technological progress with the level of population growth in the nation, on the basis of the Solow model, which identifies or forecasts the level of progress in the country with a change in the level of population growth, technological changes, capital assimilation changes, change in the demand factor in the economy in the country.

Answer (b): As a result of the lump-sum tax on all the individuals of the society, the level of income at the hands of the people would now decrease, thereby leading to a situation where the people would now want to buy less or in other words the demand for capital stock in the market would now increase in the market, hence leading to an increase in the steady state position in the economy. This implies that the steady State capital stock would now get lesser as a result of the increase in the increase in the demand of capital in the market.

Answer (c): The Golden rule of the level of per capita capital stock in the market would get affected in a way that due to increase in the demand for capital stock in the market, the interest rate would be higher and the level of depreciation in the economy would also increase in the long-run, thereby satisfying the necessary conditions that now prevail due to an increase in the interest rate as a result of the demand in the capital stock in the economy.