Question

Use the Solow growth model to answer the questions below. Suppose the population growth rate decreases in a permanent manner.

a. Explain the impact on capital per worker.

b. Explain the impact on output per worker.

c. Explain the impact on consumption per worker

Answer 1

A decrease in population growth rate leads to decrease in the labor force growth rate in the economy which causes changes in the steady state level of capital per capita and output per capita in the economy. The impact of these changes are depicted in the diagram below:

The intial steady state equilibrium in the economy occurs at point E1 where k1* reprsents the steady state level of capital per capita where savings rate is equal to break even investment and y1* represents the steady state level of output per capita in the economy. A decrease in population growth rate will shift the line of break even investment downwards and new steady state equilibrium occurs at point E2 where the level of capital per capita and output per capita has increased to K2* and y2* respectively. The consumption per capita is the difference between the per capita output curve and savings curve at the corresponding level of capital per capita which has also increased as both output per capit and capital per capita has increased.