Question

Suppose z' and K increase at the same time. Show that it is possible for the real interest rate to remain constant as a result. What does this say about the model's ability to explain the differences between poor and rich countries and to explain what happens as a country's economy grows?

Answer 1

1) We will assume z' as a factors of production and K is the capital. The factors of production - Land, Labour, Capital and Organization have direct proportion to the Real interest Rate. But the Real interest rate should have the assumption of being excluding the nominal rate of interest and also taking into the consideration of the existing inflation rate.

Thus it is explained as Real rate of interest = z'+K-nominal rate of interest which remains constant.

2) There are two type of economies prevails. One is Developed Economies and the another one is Developing Economies. Here The Developed Economies have the previlege of faster economic growth with the high indicator of huge level of Per Capita Income in the long run. Per Capita Incomes directly influences the Factors of productions. So the Real interest Rate always constant amidst the cost of production as well as in the capital increses to the huge extent.

This level travels in the negative way in the Developing type of Economies. Less Margin of Per Capita Income leads to Less consumption and less production. As rate of Supply and Demand also increases. So Real Interest Rate varies due to fluctuation prevailing in the inflation rate by experiencing downtrodden effects of factors of production not much constributing to the production funtion. Atlast Economy grows very slow in the Developing Economy.