Beginning from a steady state in the Solow growth model, explain how an increase in the...

Beginning from a steady state in the Solow growth model, explain how an increase in the savings rate will affect the levels and growth rates of capital and output per worker?

Expert Solution

Answer.

Solow model shows that saving rate is an important factor that determine steady state capital stock. When saving rate increase then economy will have large capital stock and high level of output at steady state.

The Solow model shows that increase in saving rate will increase the growth rates of capital and output per worker. But this increase will be only temporary because once an economy attains new steady state , growth will eventually stop. Therefore it is said that saving rate will have only level effect.

The following diagram depicts the effect of higher savings on growth where k* is the steady state level of capital per worker and k** is the steady state after increase in the saving rate. Y axis is depreciation and investment, whereas X axis is capital per worker.

Rahul Sunny answered 1 year ago

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