Suppose we started out at the steady state capital stock in the basic Solow growth model....

Suppose we started out at the steady state capital stock in the basic Solow growth model. If there subsequently were a decrease in the demand for loanable funds due to less favorable tax treatment of business investment (and no shift in the supply of loanable funds), then we would expect to see:

a. economic growth rates increase in the short run and the nation's capital stock to grow from its current level.

b. economic growth rates become negative in the short run and the nation's capital stock to grow from its current level.

c. economic growth rates increase in the short run and the nation's capital stock to decrease from its current level

d. economic growth rates become negative in the short run and the nation's capital stock to decrease from its current level.

e. economic growth rates stay the same in the short run and the nation's capital stock to grow from its current level.

Expert Solution

When there is decrease in the demand of the loanable funds due to less favourable tax treatment:

a) Economic growth rate would not increase because the demand is less and that will impact the production which in turn will decrease the growth rate. The capital stock could not increase from its level due to less demand and money supply. So this option is incorrect.

b.) Economic growth rate would become negative which is true due to decrease in the demand and lower productivity but the capital stock would not increase from its level due to less demand and money supply. So this option is incorrect.

c.) Economic growth rate would not increase but the capital stock would become negative which is true because less demand would decrease the capital due to lower productivity. So this option is incorrect.

d.) Economic growth rate would decrease due to less demand and lower productivity and money supply and even the nation's capital stock would become negative due to less demand and money supply. So this option is correct.

e.) Economic growth rate would not stay the same due to lower demand and neither the nation's capital stock would increase due to less money supply. So this option is incorrect.

Rahul Sunny answered 1 year ago

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