Week 3

Question 1

Solow growth model

Answer 1

Augments production model with Capital Accumulation

Question 2

Capital accumulation equation

Answer 2

ΔK(t+1) = It - d̅Kt

So, ΔK Change in capital, depends on the new investment minus depreciated capital, ie. net investment

Question 3

Equations to solve the Solow model

Answer 3

ΔK = s bar Yt - d̅Kt

Question 4

What happens at the steady state?

3 factors that change the steady state

Answer 4

No change in capital, ΔKt = 0. Production doesn’t grow anymore.

1. Higher saving rate increases K*
2. Higher A (TFP), higher K*
3. Higher depreciation rate, lower K*

Question 5

Process of Transition Dynamics

Answer 5

Takes economy from initial level of capital to steady state, and stays at K* forever.
As K moves to its steady state, output will also move to its steady state

Question 6

What is the consequence of the Solow growth model?

Answer 6

We can have growth through capital accumulation. Growth in capital corresponds with growth in output.

Question 7

2 reasons why the productivity parameter A̅ has a larger exponent in the Solow model (3/2 vs 1) than in the production model

Answer 7

1. Higher A̅ raises output directly just as in production model
2. Higher A̅ also leads economy to accumulate more capital

Question 8

What does it mean when the investment curve is above the depreciation line?

Answer 8

The difference tells us how much capital will increase from this year to the next. .

Question 9

If population (L) is growing, what happens to the steady state production?

If assume labour force is constant?

Answer 9

Output in Steady state is growing.

Output in steady state is constant.

Question 10

In steady state, what happens to the GDP per capita if population is constant, and if pop. is growing?

*Solow model shows that TFP is more important in explaining per capita output, than investment rate & dep. rate!

Answer 10

In steady state, GDP per capita is constant even if population is growing, b/c output is growing at same rate as pop.

Question 11

Change in capital equation in terms of GDP per capita

Answer 11

Δk = sAf(k) - dk

sAf(k) = dk

Question 12

Capital to output ratio, K/Y is equal to?

Answer 12

K/Y = sbar / dbar (ratio of investment rate to depreciation rate)

Question 13

According to the Solow model, does capital accumulation cause long-run growth?

Answer 13

No.

Big difficulty of Solow model is in explaining LONG-RUN growth. Solow model can only explain catch-up growth. Solow model: once reach steady state, no more growth.

Question 14

2 ways to change the steady state level of capital

If we keep increasing s, can we have growth forever?
No, b/c s is a number between 0 & 100%.

Answer 14

1. If saving rate increases, K* becomes higher to K** & output also increases to Y**
   - new investment curve increases and becomes steeper
2. If depreciation rate increases, K** is lower and output Y** also lower.

The farther we are from steady state, the FASTER we grow b/c the bigger the difference between investment and depreciation. due to diminishing returns of capital.

Question 15

3 main points of the Principle of Transition Dynamics

Answer 15

1. If an economy is below steady state, it will grow.
2. If an economy is above SS, growth rate is negative.
3. Output changes more quickly if further from SS. If closer to SS, growth of economy is slower.
   - this allows us to understand why economies grow at different rates.