Answer to Question #223442 in Macroeconomics for Amoa

Question

Suppose the government wants to double the steady state value of output per effective worker by using policies to change the saving rate. Determine the new saving rate and use the Solow growth diagram to show the effect of the policy change on the growth rate of capital per effective labour in both the short- and long run.

Answer 1

Solution:

The new saving rate will increase which will result in higher steady-state capital stock and a higher level of output. The shift from a lower to a higher steady-state level of output causes a temporary increase in the growth rate in the short run and ultimately a permanent increase in the rate of economic growth in the long run. Therefore, the growth rate of capital per effective labor will also increase.

 

This is depicted by the below graph: