Question

4. How would each of the following changes affect the steady state values of capital per worker and output per worker? a. A large fraction of the physical capital stock is destroyed in a war. b. A negative supply shock sharply reduces productivity.

Answer #1

a.

If the large fraction of the physical capital stock is destroyed, then the k* and y* remain same and not change. It is because both are at the steady-state level. Due to convergence theory, economy will be back to its initial steady state and the capital per worker would become independent of the Actual Capital Stock.

**So, Both Capital and
Output per worker remains unchanged.**

b.

A sharp reduction in productivity shifts the investment curve downward. As a result, a fall in the investment of new capital stock would lead to fall in capital per worker and consequently would have a negative impact on the output per worker. Also a fall in the productivity has negative impact on the long run growth of output.

**So, Both Capital and
Output per worker falls.**

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