Suppose that the the economy i

Suppose that the the economy is in a steady state where thecapital stock per worker is above the golden-rule level. Illustratethis situation. To obtain the golden rule steady state, how shouldhouse- holds change their rate of savings? Suppose that the savingrate decreases at time t0. On a graph plot c, k, and i against tand show how the economy adjusts between the original and the newsteady-state. Briefly explain why each variable is changing in theway that you have drawn it in your diagram.

Answer:

Suppose that the economy is in a steady state where the capitalstock per worker is above the golden rule level . Then , to rech atgolden rule steady state, policymakers must reduce the savingsrate.

Initially, when savings rate (s) decreases ,then consumption per worker (c) rises and investment per worker (i)falls.

Now, i<dk (Because investment anddepreciation were equal in the initial steady state, and after fallin investment , now investment will now be less than depreciation),which means the economy is no longer in a steady state.

As a result, gradually the capital stock per worker, k falls,which leads to fall in investment (i) and fall in output (y) andalso fall in consumption per worker (c) .

But this consumption per worker level is more than the oldsteady state c.

By reducing the savings rate , the economyobtains the golden rule steady state where consumption per workeris at higher level, output , capital and investment per worker isat low level.


 
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