Explain what would happen to per-capita income in an Open-Economy Solow model as a previously closed...

Explain what would happen to per-capita income in an Open-Economy Solow model as a previously closed country with relatively high savings rates becomes an Open Economy.

Expert Solution

The Solow–Swan model is an economic model of long-run economic growth set within the framework of neoclassical economics. It attempts to explain long-run economic growth by looking at capital accumulation, labor or population growth, and increases in productivity, commonly referred to as technological progress.

The Solow Model for an Open Economy:

An open economy characterized by the Solow model and capital that will flow into or out of the country to set the marginal product of capital, net of depreciation, equal to the world interest rate. That is: r = f '(k) – ?.

Once an economy is open, the level of capital jumps to the level determined by the interest rate. After that capital (per worker) is constant. Similarly, the wage is constant. There are still dynamics of the stock of domestically-owned assets, however. The differential equation governing their evolution is just a = s [(r +) a+ w] - (n+ g +) a whereas, High Savings Rates promote Economic Growth. Savings and economic growth have a positive correlation.

Rahul Sunny answered 2 years ago

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