Question

Consider a Solow Economy that begins with a capital stock equal to $300 billion and suppose its steady state level of capital is $500 billion. To its pleasant surprise, the economy receives a generous gift of foreign aid in the form of $100 billion worth of capital (power plants, machines, tools, etc) a. Use the Solow Diagram and mathematics of the Solow model to explain what happens to the economy, both immediately and over time. b. Suppose instead of starting bellow its steady state, the economy beings at the steady state, with a capital stock of $500 billion. Answer part (a) for this case. c. Summarize what this exercise teaches you about the possible consequences of foreign aid. In this example, does foreign aid exert a long-run effect on the welfare of poor countries? What is the benefit of foreign aid?

Answer 1