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Unformatted text preview: m income that is muted compared to the analysis of part (a). FIGURE 4 450 PAE PAE1 PAE2 C PAE0 D A D’ W W2 W1 C’ A’ JP Y Y0e Ye** Ye* Question 2 Part (a) Consider Figure 1 where the original steady‐state is represented by point a. Figure 3 y/l pf1 (y/l)1* pf0 (y/l)0
a (s/l)1= (y/l) (s/l)0= (y/l) k/l (k/l)0* (k/l)1* In the Solow‐Swan model, the economy settles at its steady state because either (1) the economy is to the left of the steady state, net investment is positive and the capital‐labour ratio grows or (2) the economy is to the right of the steady state, net investment is negative and the capital‐labour ratio falls. At the steady state, growth will cease, the capital‐labour ratio will not change as saving provides just enough resources for replacement investment, not enough for any growth to the capital‐labour ratio. This provides part of the answer why over the long term, the key is productivity growth; in the long run, with a given level of total factor productivity, the economy will be at a steady‐state with zero growth. Now suppose there is an increase in productivity (reflected in an increase in total factor productivity). This will shift the production function upwards to pf1 as a given capital‐labour ratio will now yield more per capita income. At the existing level of the capital‐labour...
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