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ECON 305: INTERMEDIATE MACROECONOMICS SPRING 2011 MARK MOORE PROBLEM SET 6 SOLUTIONS A. CHAPTER 11 Quick Check 1. a. True, in a closed economy, and if saving includes public and private saving. b. False. c. True. In the model without depreciation, there is no steady state. A constant saving rate produces a positive but declining rate of growth. In the infinite-time limit, the growth rate equals zero. Output per worker rises forever without bound. In the model with depreciation, if the economy begins with a level of capital per worker below the steady-state level, a constant saving rate also produces a positive but declining rate of growth, with a limit of zero. In this case, however, output per worker approaches a fixed number, defined by the steady-state condition of the Solow model. Note that depreciation is not needed to define a steady state if the model includes labor force growth or technological progress. d. Uncertain. See the discussion of the golden-rule saving rate. e. Uncertain/False. It is likely that the U.S. rate is below the golden rule rate and that transforming Social Security to a pay-as-you-go system would ultimately increase the U.S. saving rate. These premises imply that such a transformation would increase U.S. consumption in the future, but not necessarily in the present. Indeed, if the only effect of such a transformation is to increase the saving rate, we know that consumption per worker will fall in the short run. Moreover, moving to a pay-as-you- go system requires transition costs. If these costs are borrowed, then the reduction in public saving will offset the increase in private saving during the transition. If these costs are not borrowed, then transitional generations must suffer either a reduction in promised benefits or an increase in taxes to finance their own retirement in addition to the retirement of a previous generation. Thus, whether the U.S. “should” move to a pay-as-you-go system depends on the likely resolution of intergenerational distributional issues and your view about the equity of such a resolution. f. Uncertain. The U.S. capital stock is below the golden rule, but that does
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not necessarily imply that there should be tax breaks for saving. Even if the tax breaks were effective in stimulating saving, the increase in future consumption would come at the cost of current consumption. h. False. Even if you accept the premise (that educational investment increases output, as would be implied by the Mankiw, Romer, Weil paper), it does not necessarily follow that countries should increase educational saving, since future increases in output will come at the expense of current consumption. Of course, there are other arguments for subsidizing education, particularly for low-income households. 2.
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