Ch 8 Economic Growth

Break-even investment

the amount of investment necessary to keep k constant

Golden Rule

In the Golden Rule steady state, the marginal product of capital net of depreciation equals the population growth rate

The Solow growth model shows that, in the long run, a country’s standard of living depends

• positively on its saving rate

• negatively on its population growth rate

An increase in the saving rate leads to

• higher output in the long run

• faster growth temporarily

• but not faster steady-state growth

If the economy has more capital than the Golden Rule level,

then reducing saving will increase consumption at

all points in time, making all generations better off

If the economy has less capital than the Golden Rule level,

then increasing saving will increase consumption

for future generations, but reduce consumption for the

present generation

1. In the Solow growth model, the economy reaches a steady state when:

A. Output per worker stops growing.

B. Capital per worker remains constant.

C. Investment equals depreciation.

2. According to the Solow model, if the saving rate increases, in the new steady state:

C. Output per worker increases, but consumption per worker may increase or decrease.

3. If the population growth rate n rises, the steady-state capital per worker:

B. Decrease.

5. In the Solow model with no technological progress, long-run growth in per capita output is:

B. Zero.

10. Explain the economic intuition behind why higher saving rates raise the steady-state level of output but not the long-run growth rate of output per worker.

A higher saving rate allows more investment, increasing the steady-state capital stock k* and thus steady-state output y*. 

However, without technological progress, per-capita output stops growing in steady state because diminishing returns to capital prevent perpetual growth. 

11. What is break-even investment?

It is the amount of investment required to keep capital per worker constant-covering both depreciation of existing capital and the capital needed for new workers due to population growth.

12. Describe how policymakers could adjust saving rate to reach the Golden Rule steady state.

Policymakers can use incentives (e.g., tax policies) to adjust national saving so that the steady-state marginal product of capital net of depreciation equals the population growth rate:

MPK - δ = n

This ensures consumption per worker is maximized in a steady state.

13. Explain the trade-off between current and future consumption in the Solow model.

Increasing the saving rate raises future consumption by allowing more capital accumulation - but reduces current consumption since households save more today. The Golden Rule balances this trade-off.

14. Based on international evidence, what does the Solow model predict about countries with high saving and investment rates versus those with high population growth rates?

Countries with higher saving/investment rates tend to have higher capital per worker and income per worker.

Conversely, countries with higher population growth rates tend to have lower steady-state income per worker.