Question

As an economy adjusts to a decrease in the saving rate, according to Solow model, we would expect output per worker

-none of the other answers is correct.

-to decrease at a permanently higher rate.

-to return to its original level.

-to increase at a permanently higher rate.

-to decrease at a constant rate and continue decreasing at that rate in the steady state.

Answer 1

Option A is correct. As there is decrease in saving rate the economy engages in an contractionary process until the new equilibrium is met. In the long run, the fall in the saving rate has produced a level effect: that is, in the new steady state, the economy will enjoy a lower level of output per worker than in the steady state before. During the transition from one steady state to the other, per capita output had decreased. But, because of diminishing returns, this decrease in output per capita was no more than a temporary phenomenon.