dse-2008 solow

[AJ]

13. in solow model of growth an increase in the savings propensity has the following impact:
a. it leads to higher steady state growth rate
b. leads to lower steady state growth rate
c. steady state growth rate remains unchanged
d. steady state growth may increase or decrease depending on degree of increase in savings propensity

the answer key to DSE 2008 says its a. should not it be c?.

[Amit Goyal]

Thats right. Its (c). Make the appropriate correction.

[aditi5000]

Consider what happens to an economy when its saving rate increases.
Figure 7-5 shows such a change. The economy is assumed to begin in a steady
state with saving rate s1 and capital stock k*1. When the saving rate increases from
s1 to s2, the sf(k) curve shifts upward. At the initial saving rate s1 and the initial
capital stock k*1, the amount of investment just offsets the amount of depreciation.
Immediately after the saving rate rises, investment is higher, but the capital
stock and depreciation are unchanged. Therefore, investment exceeds depreciation.
The capital stock will gradually rise until the economy reaches the new
steady state k*2, which has a higher capital stock and a higher level of output than
the old steady state. Mankiw (page 201)
So, doesn't this mean that the steady state growth rate where k dot =0 will also change due to the change in s?

[tim]

sir cn u pls give the reason as to why it shud the answer be C and not A...if we go by the diag wnt it increase steady state...

[Chinni18]

Hi aditi
When an economy's savings rate increases, it reaches a steady state of which has a higher capital stock and a higher level of output than the old steady state. So the long run level of capital and output per head increases. But the long run growth rate of output will not change. It will continue to remain equal to the population growth rate. The actual output per head may change but the growth rate will ultimately always fall back to the population growth level.
Basically, kdot=0 will remain kdot=0, the only difference being that it'll be so on another point on the graph

[Chinni18]

tim
It won't increase the steady state because the steady state is not affected by the savings rate. Only per capita output and k-l ratio increase/decrease.
If savings grow then capital grows. Output increases and capital accumulation takes place. But diminishing returns will hold and thus the growth rate decreases till it again declines to the population growth rate. Anywhere else there will be disequilibrium. So we can say that in long run, steady state is not affected.

[aditi5000]

Hey thank you so much Chinni, this really helped :) So does the growth rate for steady state return to the original level only in the long run or does it remain the same even in the short run?

[tim]

thnk u chinni :) for the explanation

[Chinni18]

In the short run it will change but in the long run it will come back to the same i.e. population growth rate

[tim]

so basically in the shortt run it will increase ryt..??

[tim]

hey guys cn u help with q39 2007...?? just wanted to know ho to decide on surplus or deficit...

[Chinni18]

Yes in the short run it will increase  It has to because capital accumulation is taking place in sync with the increase in savings. Refer to Dornbusch and Fischer

[tim]

ok..yaa thnk u...cn u pls temme ur answeers for 2007 q39...