Draw the Solow model diagram, labeling the steady state K On the horizontal axis, pick a...

Draw the Solow model diagram, labeling the steady state K

On the horizontal axis, pick a value greater than K for the economy’s capital stock. label it k1

Show what happens to K over time.

Does k move toward the steady state or away from it?

Solutions

Expert Solution

Solow model : Horizontl axis represents the capital stock per worker and vertcal axis represents the investment, depreciation , output per worker.

At steady state there is a breakeven investment point . This implies that where the line from the orign cuts the investment curve.

Now, if the capital per worker is greater than steady state . It is represented by k1 in the above figure.

Initially , to came back k to the staedy state level .Savings decreases and therefore, consumption increases. And investment decreases. Therefore, investment decreases. Now, investment is less than the total depreciation.

So, capital per worker rises , as a result investment decreases further and output decreases. And therefore, consumtpion per wokrer also decreases. But this consumption level is greater than the old steady state consumtpion level.

Therefore, over time, k move towards the staedy level by decreasing the savings rate.

Rahul Sunny answered 1 year ago

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