Question

In the solow growth model show what happens when the depreciation rate d decreases. Show the transition of the country from its original steady state to its new steady state.

Answer 1

In a solow growth model a fall in the rate of capital depreciation shifts down the (n + d)k line from (n + d₁)k to (n + d₂)k. The equilibrium steady-state capital-labor ratio, output per worker ratio is higher, so consumption per worker is higher. There is no effect on the long-run growth rate of the total capital stock, because in the long run the capital stock must grow at the same rate (n) as the labor force grows, so that the capital-labor ratio is constant.