Answer to Question #290897 in Macroeconomics for lisa

Question

With the help of the Solow growth model diagram, explain the

effects of shocks on steady state per worker capital and output.

Answer 1

One of the shocks can be technological change which can have an uneven development and progress.

For example, if there is a positive technological change with a factor A, the initial state of equilibrium, actual investment exceeds what is required and this translates to an increase in capital per worker ratio. The economy moves to a new state of equilibrium to correspond to the higher capital per worker ratio. It moves from K$_1$ to K$_2$

This causes faster growth of output than the previous state of equilibrium. Therefore the technological shift causes an increase in output and hence the savings. If the technology drops, the capital ratio goes back to the initial level but growth takes time and does not finally go back to the original position. This impact of technological shock can be explained diagrammatically as below;