Question

Our closed economy starts off in steady state. Suppose it is suddenly hit with an outbreak mad bat disease. This disease is caught by a large percentage of the population and unfortunately some people die. Another result there is a permanent decline in fertility rates (as described by the number of children born per adult female) and a permanent increase in government spending on medical interventions such as testing, vaccines and other interventions.

Using one Solow model diagram and words to describe new steady state and the the very long-run transition to that steady state. (Label the initial steady state by A and the new steady state by B)

Is the economy better off or worse off once it arrives at the new steady state?

Don't forget to describe both the levels and growth rates of capital, output & consumption per effective worker comparing these to their initial steady state values.

Answer 1

There is fall in the population, it raises the capital per workers temporarily. Further, there is fall in the fertility rate. The fall in the fertility rates shifts the breakeven investment line to down whereby causing the rise in the steady state output level.

Following is the diagram:

The fall in population has transient effects, but change in growth of population has steady state effects: