Consider A Numerical Example Using The Solow Growth Model

Consider A Numerical Example Using The Solow Growthmodel Suppose That

Consider a numerical example using the Solow growth model. Suppose that F(K, N) = K^0.5 N^0.5; with d = 0.07; s = 0.25; n = 0.02; and z = 2.

a. Determine capital per worker, income per capita, and consumption per capita in the steady state.

b. Instead of part b of the question 7, find the golden rule quantity of capital per worker. Is there overinvestment or underinvestment in this economy, relative to the golden rule?

Paper For Above instruction

The Solow growth model serves as a fundamental framework in understanding long-term economic growth by analyzing the roles of capital accumulation, labor or population growth, and technological progress. In this particular numerical example, we examine the steady-state conditions given a specific production function, savings rate, depreciation rate, population growth rate, and technological factor. Additionally, the exercise involves identifying whether the economy is over- or under-invested relative to the golden rule level of capital accumulation, which maximizes steady-state consumption.

Introduction

The Solow model posits that output in an economy depends on capital and labor, with technological progress enhancing productivity over time. By analyzing the production function, the savings rate, depreciation, population growth, and technology, the model seeks to determine the sustainable level of output and capital per worker in the long run. This paper first calculates the steady-state values for capital, income, and consumption per capita, given the parameters. Subsequently, it assesses the investment level relative to the golden rule savings rate to determine whether the economy is over- or under-investing.

Part A: Steady-State Capital, Income, and Consumption Per Capita

The production function is specified as F(K, N) = K^0.5 N^0.5, which implies constant returns to scale and a Cobb-Douglas form. To analyze per worker terms, define k = K/N as capital per worker, and y = Y/N as income per worker. Given the production function and the technological factor z = 2, the output per worker becomes:

Y/N = z (K/N)^0.5, which simplifies to y = 2 k^0.5.

The steady-state condition in the Solow model is where investment equals the depreciation plus the effective depreciation due to population growth. Formally, this is:

s y = (δ + n + gz) k, where δ is the depreciation rate, n is the population growth rate, and g is the technological growth rate. Assuming no explicit technological growth or G in the formula, considering the technological factor as a multiplicative constant in productivity, the effective depreciation becomes δ + n, leading to the equation:

s y = (δ + n) k.

Substituting y = 2 * k^0.5 into the steady-state condition produces:

0.25 2 k^0.5 = (0.07 + 0.02) * k,

which simplifies to:

0.5 k^0.5 = 0.09 k.

Dividing both sides by k^0.5 (since k > 0), yields:

0.5 = 0.09 * k^0.5,

and further solving for k^0.5 gives:

k^0.5 = 0.5 / 0.09 ≈ 5.5556.

Squaring both sides to find k:

k ≈ 5.5556^2 ≈ 30.86.

Now, the income per capita y is:

y = 2 k^0.5 ≈ 2 5.5556 ≈ 11.1112.

Consumption per capita c is derived from savings, i.e., c = (1 - s) * y:

c ≈ (1 - 0.25) 11.1112 ≈ 0.75 11.1112 ≈ 8.3334.

Thus, in the steady state, the key variables are:

  • Capital per worker (k): approximately 30.86
  • Income per capita (y): approximately 11.11
  • Consumption per capita (c): approximately 8.33

Part B: Golden Rule Level of Capital per Worker and Investment Analysis

The golden rule level of capital per worker is achieved when the marginal product of capital equals the sum of the depreciation rate and the effective growth rate of the economy, i.e., MPK = δ + n + g. For the Cobb-Douglas function, the marginal product of capital is:

MPK = 0.5 z N^0.5 / K^0.5 = 0.5 * y / k.

Setting MPK equal to δ + n gives:

0.5 * y / k = 0.09.

Substituting y = 2 * k^0.5, the equation becomes:

0.5 (2 k^0.5) / k = 0.09,

which simplifies to:

(k^0.5) / k = 0.09,

or:

1 / k^0.5 = 0.09,

leading to:

k^0.5 = 1 / 0.09 ≈ 11.1111.

Squaring both sides yields:

k ≈ 11.1111^2 ≈ 123.46.

Therefore, the golden rule level of capital per worker is approximately 123.46, significantly higher than the steady-state level of 30.86. Correspondingly, the golden rule income per capita is:

y_GR = 2 (123.46)^0.5 ≈ 2 11.1111 ≈ 22.2222.

And the optimal consumption per capita at the golden rule is:

c_GR = (1 - s) y_GR ≈ 0.75 22.2222 ≈ 16.6667.

Comparing the steady-state consumption (8.33) and the golden rule consumption (16.67), it appears the current level of investment and capital accumulation is below the optimal. This underinvestment suggests that increasing savings (or investment) to reach the golden rule level would maximize steady-state consumption, highlighting the economy's potential for improved growth and welfare.

Conclusion

This analysis demonstrates the application of the Solow growth model to a specific numerical example, highlighting the steady-state levels of capital, income, and consumption per capita. The findings suggest that, given the current parameters, the economy is underinvested relative to the golden rule capital stock, emphasizing the importance of adjusted savings policies. This underinvestment constrains potential consumption and long-term growth, underscoring the relevance of policy measures that lead towards optimal capital accumulation levels.

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