Question

Solow Growth Model Question: Consider an economy where output (Y) is produced according to function Y=F(K,L). L is number of workers and Y is the capital stock. Production function F(K,L) has constant returns to scale and diminishing marginal returns to capital and labor individually. Economy works under assumption that technology is constant over time. The economy is in the steady-state capital per worker. Draw graph. Next scenario is that the rate of depreciation of capital increases due to climate change and flooding. Use a diagram to explain what effect this will have on income per worker in the long run. Provide graph and explanation

Answer 1

Economy intially at steady state at point E. The steady state level of capital and output per worker are k1* and y1*.

Due to increase in the depreciaiton rate (), the depreciation line shifts up from ( + n)k to (1 + n)k, where 1 > .

There is a backward movement on the investment curve (i = s*f(k)) from point E to E1.

The new steady state level is E1 where both Output and capital per worker decreases to y2* and k2*.