ECON 101 - Macroeconomics

First Semester, AY 2024-2025

Name: Stephanie L. Gabriel ECON 101-N

PROBLEM SET NO.3

1. [10 points] What is the steady state in the Solow growth model? How do countries
not in the steady state go towards the steady state? Explain using graphs and
equations. Do you think the Philippines is in its steady state? Why or why not?
Explain using Philippine data and, if necessary, graph of the Solow growth model.

Answer:

In the Solow growth model, the steady state is a long-run equilibrium where the economy's
capital stock per worker and output per worker remain constant over time. Specifically, in this
steady state, the economy reaches a level where investments in new capital just offset depreciation
and population growth, so that the capital per worker (or capital-labor ratio) remains constant.

If the country’s economy is not in its steady state, it will tend to converge towards it. For
example, if an economy's capital stock per worker is below the steady-state level, investment will
exceed depreciation, leading to capital accumulation and economic growth. Conversely, if the
capital stock per worker is above the steady-state level, depreciation will exceed investment,
leading to capital depletion and economic decline.

Graph
In the graph, the steady-state level of capital per worker is represented by the intersection of the
savings and depreciation curves. If the economy starts below the steady state , investment exceeds
depreciation, leading to capital accumulation and economic growth. As the economy moves
towards a steady state , the growth rate slows down.

Conversely, if the economy starts above the steady state, depreciation exceeds investment, leading
to capital decumulation and economic decline. As the economy moves towards the steady state
(point B), the decline slows down.

Equation: ΔK = sf (k) - δK

1. ΔK, this represents the change in capital stock over a period. It's essentially the net
investment, or the amount of new capital added to the economy.
2. sf (k), this term represents savings. The variable 's' is the savings rate, which is the
proportion of output (k) that is saved and invested.
3. δK, this term represents depreciation. The variable 'δ' is the depreciation rate, which is the
rate at which capital stock wears out or becomes obsolete.

When a Country is Not in Steady State

In this case, sf(k) > δK, this means that the economy is saving and investing more than it's
losing to depreciation. As a result, the capital stock (K) increases over time. With more capital, the
economy can produce more output (Y).

In this case, sf(k) < δK. This means that the economy is not saving and investing enough
to replace the capital stock that's wearing out. As a result, the capital stock (K) decreases over
time.With less capital, the economy can produce less output (Y).

Is the Philippines in its Steady State?

Determining whether the Philippines is in a steady state is a little bit confusing and complex
but here is the data which analyzed the main indicators for the second quarter this year. For me,
based on the data provided, the Philippines is not in a steady state.
 1. In Q2 2024, the Philippines achieved a GDP growth rate of 6.3%, with projections for 6-
7% growth for the year. A significant rise in investment, particularly in the construction
sector, which grew by 16.0%, indicates ongoing capital accumulation. This positive trend
supports the country's potential for sustained economic growth.
2. By June 2024, employment conditions in the Philippines improved, with a labor force
participation rate of 66.0%. This steady participation, alongside rising investments,
supports sustainable economic growth. However, the rapid increase in labor force
utilization suggests that further growth from increased employment may be limited unless
there are advancements in productivity or technology.
3. In the Solow model, reaching a steady state means that the benefits of increasing capital
per worker are offset by diminishing returns. The report highlights that significant
technological advancements, which are essential for achieving higher growth beyond the
steady state, are not evident. Instead, growth is primarily fueled by capital investments and
positive conditions in the services and industry sectors. While this is beneficial, it does not
provide the productivity enhancements that come from technological progress, suggesting
that growth may slow as capital accumulation starts to yield lower marginal returns..
4. Headline inflation was at 3.8% in Q2, with the BSP maintaining a policy interest rate of
6.5%. Controlled inflation supports investment stability, but the BSP’s decision to hold
rates steady also reflects caution in maintaining sustainable growth without overheating the
economy. If inflation remains within target while growth rates stabilize, this could indicate
a near-steady state condition.

Recent Philippine data on savings rates, investment rates, population growth, and depreciation
would allow us to assess whether the Philippines is still transitioning towards its steady state or
has achieved it. Current low savings rates and high population growth suggest that the Philippines
may not yet be in its steady state, as these factors imply a potential gap between required
investment and actual capital stock per worker.
2. [10 points] From the 1960s to 2022, the fertility rate has halved from 7.1 births per

per woman in 1960 to 2.7 in 2022. Using a graphs and equations of the Solow growth

model, explain how this affected the output of the Philippines. What are the policy

implications that can be derived from this?

Graphs:

The decline in the fertility rate in the Philippines, from 7.1 to 2.7 births per woman, has
significant implications for economic growth, as it results in a smaller future working-age
population and reduced labor force growth. This reduction may slow down economic growth due
to fewer workers available for production. However, it also leads to an increase in capital per
worker, as existing capital is distributed among fewer workers, potentially enhancing productivity
and output. Additionally, a lower fertility rate can create a demographic dividend by increasing
the proportion of the working-age population, which can stimulate economic growth through
higher savings, investment, and productivity. In the context of the Solow Growth Model, this
demographic shift may raise the steady-state level of output per worker, although it may also
require a period of adjustment as the economy adapts to these new demographic conditions.
Equation: Δk= sf(k)−(δ+n + g)k
1. As fertility rates decline, the population growth rate (n) is expected to decrease. A lower
(n) means that the economy will require less new capital to equip a growing labor force,
which can positively affect the change in capital stock (ΔK).
2. With a reduced n, the term (δ+n+g) will be smaller. This reduction indicates that there will
be less capital needed to support a growing population. Consequently, this could lead to a
situation where the savings from sf(k) can be more effectively channeled into accumulating
capital per worker, leading to higher output per worker.
3. As the capital-to-worker ratio increases due to declining population growth, output per
worker is likely to rise, assuming that the capital is effectively used and the production
function f(k) remains consistent. This could potentially lead to increased productivity,
which is critical for sustaining economic growth in the face of a shrinking labor force.
4. The equation also highlights the role of technological progress (g). If the rate of
technological advancement does not keep pace with the declining labor force, the economy
may struggle to maintain its growth trajectory. Encouraging innovation and productivity
enhancements will be essential to offset the negative effects of a smaller workforce.
5. As for the savings Rate (s), a stable or increasing savings rate is crucial in this context. If
the savings rate remains high, the available capital for investment will grow, allowing for
more robust capital accumulation despite a declining workforce. This means that with
effective savings and investment strategies, the economy could still thrive even as fertility
rates drop.

Policy Implications
To leverage the demographic dividend it should invest in human capital prioritizing
education and healthcare to enhance the skills and health of the workforce. promote economic
opportunities by creating jobs, particularly in emerging industries, to absorb the growing
workforce. Encourage entrepreneurship like supporting small and medium-sized enterprises to
stimulate economic growth and job creation. Enhance social protection through strengthening
social security systems to provide adequate support for the elderly and vulnerable populations.
Additionally, to address the challenges of an aging population, promote active aging by
encouraging older individuals to remain active in the workforce and volunteer in their
communities. Lastly, address gender inequality and reproductive health. Promote gender equality
and expand access to family planning services. Thus, by effectively managing the demographic
transition and implementing appropriate policies, the Philippines can harness the potential benefits
of a declining fertility rate and achieve sustainable economic growth.

References:
Economic Financial Data / Philippine Statistics Authority/ Republic of The Philippines ( 2024,
August 8) https://psa.gov.ph/content/economic-financial-data-philippines
Mankiw, N.G (2016). Macroeconomics (9th Ed) World Publishers