Question

4. Use the Solow growth model to graph and illustrate how higher technological progress (an increase in g) will impact the steady-state capital per effective worker (k*), the steady-state level of output per effective worker (y*), and the steady-state level of consumption per effective worker (c*). Show each of these on the graph before and after the increase in technological progress and indicate how the higher technological progress will shift the curves on the graph.

Answer 1

We assume the per-capita production function of the form: y = f(k)

Initially, the economy is at steady state at k₁, with investment i₁ = sf(k₁) and consumption, c₁ = y₁ –i₁.

After the increase in g₁, the breakeven investment line shifts from (ẟ + n + g₁) to (ẟ + n + g₂). This shift results in increase of per capita capital to k₂, with investment increasing to i₂ = sf(k₂) and consumption, c₂ = y₂ –i₂. Thus, with increased technological progress, the economy grows faster as reflected by the increased steady state values.

The diagram below depicts the situation: