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Unformatted text preview: 1 91 LongRun Economic Growth, Part 2 92 Agenda • Fundamental Determinants of Living Standards. • Policies to Raise LongRun Living Standards. 93 The Solow Model • Fundamental determinants of living standards: ¾ The saving rate. ¾ Population growth. ¾ Productivity growth. 94 The Solow Model • Fundamental determinants of living standards: ¾ Increasing the saving rate: 2 95 A Effect of an increase in the saving rate K/N Y/N S/N = s*A *f( K/N ) I b /N = (n + d)K/N Y/N = A *f( K/N ) (Y/N) A (S/N) A = (I b /N) A (K/N) A 96 The Solow Model • The adjustment mechanism: ¾ A higher saving rate shifts the saving function up. ¾ At the original K/N , at (K/N) A , S/N is now greater than I b /N . ¾ Consequently, K/N will increase, causing: • Y/N to increase along the production function, • S/N to increase along the new saving function, and • I b /N to increase along the balanced investment function. 97 The Solow Model • The adjustment mechanism (continued): ¾ Because of diminishing marginal product of capital, the increase in S/N is smaller than the increase in I b /N for every increase in K/N . ¾ Eventually S/N will equal I b /N at a new, higher steady state at B. 98 The Solow Model • The adjustment mechanism (continued): ¾ At B, Y/N has increased, K/N has increased, S/N has increased, and I b /N has increased. ¾ At steady state B, Δ Y/Y = Δ N/N = Δ K/K . ¾ During the transition period from steady state A to steady state B: • Δ Y/Y > Δ N/N because Y/N was increasing, and • Δ K/K > Δ N/N because K/N was increasing. 3 99 The Solow Model • Fundamental determinants of living standards: ¾ Increasing the saving rate means: • A higher capitallabor ratio, K/N , • A higher output per worker, Y/N , and • A higher consumption per worker, C/N . 910 The Solow Model • Fundamental determinants of living standards: ¾ Increasing the saving rate: • Should raising the saving rate be a policy goal? – Not necessarily. » There is a tradeoff between present and future consumption. » The cost is lower consumption in the short run. 911 The Solow Model • Fundamental determinants of living standards: ¾ Slowing the population growth rate: 912 A Effect of a faster population growth rate K/N Y/N S/N = s*A *f( K/N ) I b /N = (n + d)K/N Y/N = A *f( K/N ) (Y/N) A (S/N) A = (I b /N) A (K/N) A 4 913 The Solow Model • The adjustment mechanism: ¾ A slower population growth rate rotates the balanced investment function down....
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 Spring '08
 Staff
 Solow model, Living standards

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