Question

d) Towards the end of WWII, many factories in Germany were bombed by the Allies. Explain what this means in the context of the Solow model. If nothing else had changed, how would this have affected the growth rates and the steady-state level of standard-of-living?

e) The Gini coefficient for before-tax income in country X is 0.30, and for after-tax income it is 0.35. How do you interpret this?

Answer 1

Ans e)Definition: Gini coefficient is used for measuring international income inequality as well as income inequalitu within a given country.

A Gini coefficient of zero indicates perfect equality and 1 indicates maximal inequality.

The pre-tax Gini coefficient is calculated on income before taxes and transfers, and it measures inequality in income before taxes. The after-tax Gini coefficient—is calculated on income after taxes and transfers, and it measures inequality in income after considering the effect of taxes.

Since in country X the after-tax Gini coefficient (0.35) is more than before-tax gini coefficient (0.30), we can interpret that the income inequality has increase in the economy after taxes. This can be due to Regressive taxation i.e tax rate decreases with increase in income levels. Thus the taxation policy measure is ineffective in reducing the inequality in the country.

The government should impliment progressive tax system and increase social spending in the economy. The progressive taxation (tax rate increases with increase in income level) policy reduces tax burden on lower income households and increases tax burden on high income groups thus reducing the income inequality after taxes.

--------------------------------------------------------------------------------------------------------------------------------------------------------

Ans d)

Solow model of growth: It considers capital, labour and technology as factors of production which determine rate of economic growth of a country.
- The key point of this theory is that sustained growth and high levels of per capita income can be achieved through savings and capital accumulation.

Towards the end of WWII, many factories in Germany were bombed by the Allies. This means that there was large scale distruction of manufacturing units and loss of capital assets. So according to Solow's growth model Germany would have to increase its labour force, and savings for capital accumulation and technological progress to generate economic growth that would raise standard of living.

If nothing else had changed

- The Solow Model model predicts conditional convergence: Different countries having same saving rate and population ggrowth rate and access to same technology will ultimately converge to same per capita income (this process may take different time in different countries).
- That is if the poor countries save at the same rate as rich countries and have access to the same technolgy they will eventually catch up. Eg. Japan and Germany after WW2.

- Steady state equilibrium means that growth rate of output equals growth rate of labour force and growth rate of capital, which means that income and capital must be growing at the same rate as labour force.
- Steady state rate of growth of per capita income, that is long run growth rate is determined by progress in technology.

The two main factors for germany's fast growth were currency reform and the elimination of price controls