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Questions for Review
1. In the Solow growth model, a high saving rate leads to a large steadystate capital
stock and a high level of steadystate output. A low saving rate leads to a small steady
state capital stock and a low level of steadystate output. Higher saving leads to faster
economic growth only in the short run. An increase in the saving rate raises growth
until the economy reaches the new steady state. That is, if the economy maintains a
high saving rate, it will also maintain a large capital stock and a high level of output,
but it will
not
maintain a high rate of growth forever. In the steady state, the growth
rate of output (or income) is independent of the saving rate.
2. It is reasonable to assume that the objective of an economic policymaker is to maximize
the economic wellbeing of the individual members of society. Since economic wellbeing
depends on the amount of consumption, the policymaker should choose the steady state
with the highest level of consumption. The Golden Rule level of capital represents the
level that maximizes consumption in the steady state.
Suppose, for example, that there is no population growth or technological change.
If the steadystate capital stock increases by one unit, then output increases by the
marginal product of capital
MPK
; depreciation, however, increases by an amount
δ
, so
that the net amount of extra output available for consumption is
MPK
–
δ
. The Golden
Rule capital stock is the level at which
MPK
=
δ
, so that the marginal product of capital
equals the depreciation rate.
3. When the economy begins above the Golden Rule level of capital, reaching the Golden
Rule level leads to higher consumption at all points in time. Therefore, the policymaker
would always want to choose the Golden Rule level, because consumption is increased
for all periods of time. On the other hand, when the economy begins below the Golden
Rule level of capital, reaching the Golden Rule level means reducing consumption today
to increase consumption in the future. In this case, the policymaker’s decision is not as
clear. If the policymaker cares more about current generations than about future gen
erations, he or she may decide
not
to pursue policies to reach the Golden Rule steady
state. If the policymaker cares equally about all generations, then he or she chooses to
reach the Golden Rule. Even though the current generation will have to consume less,
an infinite number of future generations will benefit from increased consumption by
moving to the Golden Rule.
57
CHAPTER
7
Economic Growth I
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View Full Document 4. The higher the population growth rate is, the lower the steadystate level of capital per
worker, and therefore there is a lower level of steadystate income per worker. For
example, Figure 7–1 shows the steady state for two levels of population growth, a low
level
n
1
and a higher level
n
2
. The higher population growth
n
2
means that the line rep
resenting population growth and depreciation is higher, so the steadystate level of cap
ital per worker is lower.
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This note was uploaded on 04/07/2011 for the course ECON 381 taught by Professor Staff during the Winter '08 term at BYU.
 Winter '08
 Staff

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