Question

Graphically illustrate the impact of the following events on real GDP per capita in a balanced- growth-path equilibrium. Keep in mind that the Solow model graph provides qualitative predictions for variables such as real GDP per effective worker (y), and that real GDP per capita is given by Y/L = A × y.

1. a) For the first time in modern history, the birthrate in Japan falls below the mortality rate. (5 points)

2. b) A megathrust earthquake, much like the 2004 Indian Ocean earthquake, along the Cas- cadia subduction zone destroys all buildings and infrastructure in Washington, Oregon, and northern California. Due to a newly developed earthquake early warning system, the loss of life is minimal.1 (5 points)

Answer 1

a).

Consider the given fig. So, here “y=f(k)”, be the production function of “Japan” and “E1” be the steady state equilibrium where “s*y” and “(n+d)*k” cross to each other. So, here the steady state “k” and “y” are given by “k1*” and “y1*”.

Now, as the birth rate falls below the mortality rate, => the population growth decreases, => “(n+d)*k” line become flatter. So, the new steady state equilibrium is given by “E2” where “s*y” and new “(n+d)*k” cut to each other. So, here both equilibrium “k” and “y” increases.

b).

Consider the given fig US economy and “E1” be the steady state equilibrium where “s*y” and “(n+d)*k” cross to each other. So, here the steady state “k” and “y” are given by “k1*” and “y1*”.

Now, because of the megathrust earthquake will destroy all the infrastructure and buildings, => the capital stock per worker as well as the output per worker decreases. Now, because the savings rate remain same as before, => at this new “k=k2” the change of “k” is positive, => “dk > 0”, => “k” further starts increasing and will continue to increase until new steady state equilibrium will established.