solow model

[s]

dse 2008

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?...as in, in transition to new steady state the growth rate changes but at new steady state it goes back to original value or has the question been asked for transition period  ?

please help..

[deepak]

When the propensity to save increases, nothing changes physically in the economy except for the fact that consumption goes down and savings increases, shifting the investment curve upwards. However, all this while, the depreciation curve does not change (this is affected only by exogenous factors like depreciation rate, population growth etc). So the only change we observe is the investment curve intersecting the depreciation curve at a higher k*. Note that it won't go back to the original level because at the new level, depreciation = investment (ie steady state). Hence the new steady state level is higher than the old one. If you plot the investment and depreciation curves on a graph this will be clear.

[s]

steady state LEVEL of per capita capital stock does increase true..but as far as i know steady state GROWTH RATE does not change it still equals rate of population growth at the new steady state....

[deepak]

Ah apologies for the oversight there. Yes you were correct in what you had mentioned in the original post. It does look like they're not too interested with the long run, and are just looking at the short run period, where the increase in capital stock causes output to expand faster in the short run

[Chinni18]

Hey any idea about the following question?

Suppose that the production function in an economy is given by Y = (K^1/2)(N^1/2), and both the saving rate (s) and the depreciation rate (d) are equal to 0.10 and labor force growth rate is 0.02.
What is the growth rate of wage rate at steady state?

The answer is given as 0.
So does that mean growth of wages in steady state is 0?
Should it not be 0.02 i.e. the growth rate of labour supply?

[duck12]

@Chinni18
Might be the answer is wrong. If growth rate of wage in steady state is zero, how can it sustain the population growth? It is not possible i think. Answer might be wrong only

[Chinni18]

But even if the growth rate of wage is zero it might make sense, because that's what a steady state implies, isn't it?
I'm pretty confused. Have not come across anything concerning wages in the neoclassical growth model, only savings, capital, consumption etc.

[aditi5000]

hmm.. yes Chinni even I have not come across something like this before... see either wages will be constant ie zero growth rate or they will grow @ 0.02 with labour supply... i have a feeling its the latter. Someone please clarify!

[lovekesh]

http://econ161.berkeley.edu/Teaching_Folder/Econ_202a/handouts/H3.pdf
here.

[aditi5000]

As per this handout, wage grows @ k dot - and at steady state, k dot =0 so thats why the answer is zero.

[aditi5000]

Thanks!!

[Chinni18]

Wonderful! Thank you so much lovekesh!