Question

Below Statement is True, False, or Uncertain question. Justify the response. (Include Graph). Its a Macro economics question

Suppose the aim of the government is to increase the economic well-being of it’s citizens. According to the Solow-Swan model from lectures, the government should try to increase the savings rate, as this will lead to a higher steady-state level of capital and a higher level of steady-state outpur, and thus will improve economic well-being

Answer 1

Solow model is an economic long run economic growth. It attempts to explain long run growth by taking into account capital, labour, population and technological process. The key component of this model is savings and investment rate.

Effects of increasing savings in short run: When savings rises in an economy, investment rises simultaneously. Refer to the diagram, Initially we have depreciation line at 45 degree because as output rises, depreciation rises. Y(t) is total output depend on labour and capital, Y=F(K,L). i(t) is investment which is dependent on savings rate and will always be below than y(t). Where ever depreciation line intersects i(t), steady state level of output comes there, because as much there is depreciation, there is investment to cover that loss. If depreciation>investment, output must falls to come at steady state because factories are producing goods at loss. If depreciation<investment, output must rise to come at steady state because there are opportunity in economy to raise the level of output.When investment rises, refer to below diagram, the curve of i(t) shifts upward to i1(t) and there comes a new steady state which is Y1. Increasing investment shifted the output level to Y to Y1 thus increasing the economic well being in short run.

Effects of increase in savings in long run: In long run, there are population increase, there are chances that machinery go old and become faulty, buildings get old which takes more maintain cost. Labour wages get higher as we usually have some inflation rate in our economy. In total there are more depreciation level in our economy which shifts depreciation curve upward and steady state level of output declines to Y1 from Y. In long run when savings rises investment rises and the main factor of covering the losses of the depreciation is technological advancements in long run which shifts i(t) curve upwards in lower diagram. With new depreciation curve and investment curve we come back to same output level of Y.

So partially your statement is correct which is in short run but not in long run.