Why the change thats a topic for a book in itself but

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Financial Markets and Institutions
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Chapter 2 / Exercise 16
Financial Markets and Institutions
Madura
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ductive as the United States. Why the change? That’s a topic for a book in itself, but Solow tells us to look for big changes in technology, depreciation rates, and savings rates. You might ask students to read up on the subject to fi nd out which of Solow’s ideas explain Japan’s new, higher postwar produc- tivity level. CASE STUDY: THE KINDNESS OF STRANGERS: FOREIGN AID IN THE SOLOW MODEL Let’s return to Figure 5.1, the classic Solow model chart. Con- sider a country that starts off in steady state, at K* , and let’s imagine that this country receives a massive gift of foreign aid, no strings attached, funded by (name of the celebrity- driven aid-concert-du-jour). Let’s imagine that all of the aid is used to buy productive new capital equipment—no money is wasted, none is funneled into the secret bank accounts of government offi cials, and all is right with the world. At this point, something wonderful happens: the economy is more productive! Since the capital stock is higher, GDP per person is higher, and living standards are higher. There’s no doubt about that whatsoever. But what will happen to the capital stock over the next few years? Remember: more capital means more capital depre- ciation. And at any point to the right of K* , the amount of capital wearing out is greater than the amount of new invest- ment capital that society is making each year. Machines are wearing out faster than they can be replaced, and the capital stock falls. People are still richer than before the gift of aid, but each year, they are a little less rich than before. The capi- tal stock keeps declining until it is right back at its old level, K* . Keeping the capital stock at the postgift level was just too wearying, too expensive. The lesson is this: a temporary change in the capital stock only leads to a temporary change in living standards. erage of steady states and convergence. After covering this, you could just hand-wave your way through the rest of this chapter without too much diffi culty. EXPANDED CASE STUDY: DO IMMIGRANTS CUT WAGES? ONE-TIME POPULATION INCREASES IN THE SOLOW MODEL Chad worked out the model as an aggregate model in Sec- tion 5.4, and only at the end did he convert it to a per-capita model. If you take a moment to divide the equation (5.5) in the text ( Δ K t + 1 = T Y t đ K t ) by L , the fi xed number of work- ers, you can instantly turn this into a per-capita Solow model. That lets us look at Figure 5.1, the Solow diagram, in a new light. Now, the x -axis is capital per worker, and the y -axis is savings and depreciation per worker. With these, we can answer an important question: What happens if a lot of new workers show up one day? We’ve already seen from the last chapter that the instant effect (with a fixed capital stock) is that all the workers get jobs at new, lower wages—you’re just moving down the fi xed demand curve.
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Financial Markets and Institutions
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Chapter 2 / Exercise 16
Financial Markets and Institutions
Madura
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