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Solow Model - Important Example

(1) The document presents an economic model of a closed economy with population growth, capital depreciation, and household saving behavior. (2) It finds that in the steady state, capital per worker is 16, output per worker is 24, consumption per worker is 21.6, and investment per worker is 2.4. (3) For the government to double output per person, it needs policies that increase the saving rate to 20% of income, which would lead to a capital per worker of 64 and output per worker of 48 in the new steady state.

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Kangta Hunter
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64 views

Solow Model - Important Example

(1) The document presents an economic model of a closed economy with population growth, capital depreciation, and household saving behavior. (2) It finds that in the steady state, capital per worker is 16, output per worker is 24, consumption per worker is 21.6, and investment per worker is 2.4. (3) For the government to double output per person, it needs policies that increase the saving rate to 20% of income, which would lead to a capital per worker of 64 and output per worker of 48 in the new steady state.

Uploaded by

Kangta Hunter
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
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5.

(a) Desired consumption declines as the real interest rate rises because the higher return to saving encourages higher saving; desired investment declines as the real interest rate rises becauses the user cost of capital is higher, reducing the desired capital stock, and thus investment. (b)Recall that Sd = Y Cd G, so Sd = 9000 Cd 2000 = 7000 Cd .
r 2 3 4 5 6 Cd 6100 6000 5900 5800 5700 Id 1500 1400 1300 1200 1100 Sd 900 1000 1100 1200 1300 C d + Id + G 9600 9400 9200 9000 8800

(c) Y = Cd + Id + G at equilibrium. Given Y = 9,000, the equilibrium condition holds only at r = 5%. At r = 5% it is also true that Sd = Id = 1200. (d) When government purchases fall by 400 to 1600, each Sd entry in the table is higher by 400, and each Cd + Id + G entry is lower by 400. Then Y = Cd + Id + G occurs at r = 3%, and Sd = Id = 1400 at r = 3%.
r 2 3 4 5 6 Cd 6100 6000 5900 5800 5700 Id 1500 1400 1300 1200 1100 Sd 1300 1400 1500 1600 1700 C d + Id + G 9200 9000 8800 8600 8400

Problem 1:

Consider a closed economy with population growth rate of 1% per year. The per-worker production function is y=f(k) = 6k0.5, where y is output per worker and k is capital per worker. The depreciation rate of capital is 14% per year. Households consume 90% of their income and save the remaining 10% of it. There is no government. (a) What is the steady state in this economy? Answer: (a) In steady state, s.f(k) = (n + d)k 0.1 6k0.5 = (0.01 + 0.14)k 0.6k0.5 = 0.15k 0.6 / 0.15 = k / k0.5 4 = k0.5 k = 42 = 16 = capital per worker y = 6k.5 = 6 4 = 24 = output per worker

c = 0.9 y = 0.9 24 = 21.6 = consumption per worker (n + d)k = 0.15 16 = 2.4 = investment per worker (b) Suppose the government wants to double the steady state value of output per person by using policies to change the saving rate. What policies the government can use? What value of the saving rate the government needs to reach? Calculate it and show in the diagram the effect of such change. Answer: (b) To get y = 2 24 = 48, since y = 6k.5, then 48 = 6k.5, so k.5 = 8, so k = 64. The capital-labor ratio would need to increase from 16 to 64. To get k = 64, since sf(k) = (n + d)k, s 48 = .15 64, so s = .2. Saving per worker would need to double.

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