1. Draw a graph of the Solow growth model showing an economy that is in a...

1. Draw a graph of the Solow growth model showing an economy that is in a steady state that has less capital than the golden-rule steady state. Be sure to label both axes correctly as well as the three relevant curves that should appear in the graph.

How did you determine graphically where the golden-rule steady-state should be?

What would have to happen in this economy for it to reach its golden-rule steady-state?

Expert Solution

K* shows the economy which is at a steady state below golden rule steady state.

Graphically the steady state capital stock corresponding to which the slope of production function is equal to the slope of break even investment line gives the golden rule steady state as the consumption is maximized at that steady state capital stock (k^*_gold).

For the economy to reach golden rule steady state, savings should increase as the economy begins at point below the golden rule steady state. Increase in savings will lead to immediate decrease in consumption per effective worker and since at this steady state investment per effective worker was equal to break even investment per effective worker but now due to increase in investment per effective worker economy will no more be in steady state. Due to increase in investment per effective worker there will be an increase in capital stock per effective worker, output per effective worker and consumption per effective worker. This process will continue till economy reaches the new golden rule steady state. Over there consumption per effective worker will be higher than at initial steady state level.

Rahul Sunny answered 2 years ago

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