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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: The saving rate. Population growth. Productivity growth. 94 The Solow Model Fundamental determinants of living standards: 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: A higher saving rate shifts the saving function up. At the original K/N , at (K/N) A , S/N is now greater than I b /N . 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): 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 . Eventually S/N will equal I b /N at a new, higher steady state at B. 98 The Solow Model The adjustment mechanism (continued): At B, Y/N has increased, K/N has increased, S/N has increased, and I b /N has increased. At steady state B, Y/Y = N/N = K/K . During the transition period from steady state A to steady state B: Y/Y > N/N because Y/N was increasing, and K/K > N/N because K/N was increasing. 3 99 The Solow Model Fundamental determinants of living standards: 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: 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: 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: A slower population growth rate rotates the balanced investment function down....
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 Summer '08
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