Question

Suppose an economy is initially in a steady state with capital per worker below the Golden Rule level. If the saving rate increases to a rate consistent with the Golden Rule, then in the transition to the new steady state consumption per worker will:

a. always exceed the initial level.

b. first rise above then fall below the initial level.

c. always be lower than the initial level.

d. first fall below then rise above the initial level.

Answer #1

Ans. - first fall below then rise above the initial level

Explanation:

When the economy begins with less capital than in the Golden Rule steady state, the policymaker must raise the saving rate to reach the Golden Rule. The increase in the saving rate causes an immediate fall in consumption and a rise in investment.

Over time, higher investment causes the capital stock to rise. As capital accumulates, output, consumption, and investment gradually increase, eventually approaching the new steady-state levels. Because the initial steady state

was below the Golden Rule, the increase in saving eventually leads to a higher level of consumption than that which prevailed initially.

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