SECTION A:
1. D
2. E
3. D
4. B
5. E
6. A
7. C
8. E
9. A
10. D
SECTION B:
1.1. /N
Y= K^aN^-a
Y= K/N
Y=(K/N)^a
Y= K^a
1.2. It= sYt
Kt+1= Kt + It - δKt
Kt+1=Kt + sYt - δKt
Yt= Kt^αNt^1−α
Kt+1= Kt + sKt^αNt^1−α−δKt
1.3. Kt+1= Kt + sf(Kt)−δKt
Kt+1 = Kt = K*
0 = sf(K*) - δK*
Y= K^αN^1−α
Y= K^α
sK^α = δK
sK^α−1= δ
K*= (s/δ)^1/1-α
Y*= (K*)^α
Y*= ((s/δ)^1/1−α)^α
Y*= (s/δ)^α/1−α → steady state output per worker.
K*= (s/(δs)^1/1−α → steady state capital per worker.
2.1. True. According to the Solow Growth model, the economy can experience short-run
growth due to capital accumulation in the form of investment, but in the long-run, without
technological progress or population growth, the economy will reach a steady-state
where output per worker and capital per worker no longer increases. In the short run,
capital accumulation grows the economy, but due to diminishing marginal returns to
capital as capital per worker increases, the additional output generated from each new
unit of capital decreases. No population growth means the labor force will remain
constant so that there’s no additional labor to combine with capital to boost output, and
similarly if there’s no technological innovation to increase production then there will be
no economic growth. If there is no technological innovation or population growth in the
long run then there is no mechanism to push the economy out of the steady state.
2.2. False. In growth theory, the convergence hypothesis suggests that poorer countries
with lower levels of GDP have the potential to grow faster than more developed
countries, but this won’t always be the case. The convergence hypothesis says that
developing countries can catch up with developed countries by simply adopting existing
technologies and practices more easily than countries that are already advanced. This
idea is based on the assumption of diminishing returns to capital, ie. as capital
accumulates, the additional output generated from each unit of capital decreases.
Therefore, poorer countries with less starting capital should be able to achieve higher
rates of return on investment. But for this to work developing countries must have
favorable conditions ie. access to technology, political stability, sound economic policies,
human capital and infrastructure. If these conditions are not met then it won’t
experience faster growth or be able to catch up with developed countries. Historical
data on this has also shown mixed results with some countries like China achieving
rapid growth while others stagnate, therefore this claim is not universal.
2.3. False. The golden-rule level of capital refers to the level of capital accumulation in
an economy that maximizes steady state consumption per worker. MPK (marginal
product of capital) must equal to a depreciation rate of 0. At this level, the economy is
investing enough to offset depreciation while simultaneously maximizing consumption.
The saving rate determines how much output is reinvested into the economy. If the
saving rate is 0 it means that no capital is being reinvested into the economy, leading to
a decline in capital stock over time due to depreciation. Output and consumption will
reduce with a saving rate of 0 therefore this cannot be the rate at which consumption is
maximized. To achieve the golden rule, the saving rate must be greater than 0 but not
necessarily at the maximum saving rate. The golden rule doesn’t specify a particular
saving rate but rather the correct balance to achieve the maximum steady-state
consumption. If the saving rate is too low, the economy will not have enough capital to
sustain basic levels of consumption, but if it is too high, then it can lead to
underconsumption as resources may be diverted from immediate consumption to
capital accumulation.
