Answer to Question #143951 in Macroeconomics for Tanvir Alam

Question

Describe how, if at all, each of the following developments
affects the actual investment and the break-even investment (this is the linear line) lines
in the basic diagram for the Solow model:
(a) The rate of depreciation falls
(b) The rate of technological progress falls
(c) The production function is Cobb-Douglas, f(k) = kα, and capital’s share, α falls.
(d) Workers exert more effort, so that output per unit of effective labor for a given level
of capital per unit of effective labor is higher than before.

Answer 1

a)If the rate of depreciation falls, it will increase capital accumulation and higher levels of output since investment exceeds the rate of depreciation. A decrease in depreciation makes the breakeven line gentle, leading to an increase in capital stock.

b)If the rate of technological progress falls, the economy will grow slower both per capita and aggregate terms. Because of the way production function incorporates technology, a decrease in technological advancement means that less investment is needed to keep up with the growth rate making it easier to reach the breakeven.

c)When the production function of Cobb-Douglas, f(k) = kα, and capital’s share, α falls, will put a drag on a steady growth. The capital stock will start to decline and disrupt the equilibrium level.

c)When workers exert less effort, the output level will also fall because the output growth rate relies on the steady-state path of output per worker. The capital stock will diminish since the required investment per effective worker is below the breakeven line.