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**Instructor: Kostas N. Kyriakoulis
**

• • • • The first midterm will cover chapters 1,2,3, 7 and 8 (you don’t need to know the endogenous

growth analysis that appears toward the end of chapter 8). Since the first homework covered the first three chapters, this review will focus on chapters 7

and 8. Make sure that you will also review homework 1. The setup of the exam will be similar to the homework. It will have multiple choice questions

and short-answer problems. A significant fraction of your grade will be based on the short-answer problems.

Multiple choice questions (correct answer in bold) 1. Use the simple Solow model, with no population growth. In the steady state, the capital stock per worker does not change because investment equals: A) B) C) D) output per worker. the marginal product of capital. depreciation. consumption.

2. A) B) C) D)

The Golden Rule level of the steady-state capital stock: will be reached automatically if the saving rate remains constant over a long period of time. will be reached automatically if each person saves enough to provide for his or her retirement. implies a choice of a particular saving rate. should be avoided by an enlightened government.

3. A) B) C) D)

An increase in the rate of population growth with no change in the saving rate: increases the steady-state level of capital per worker. decreases the steady-state level of capital per worker. does not affect the steady-state level of capital per worker. decreases the rate of output growth in the short run.

4.

Use the simple Solow model, with no population growth. The formula for steady-state consumption per worker (c*) as a function of output per worker and investment per worker is:

* * * * *

A) B)

c = f(k ) - dk . c = f(k ) + dk .

*

C) D) c = f(k ) ÷ nk . assumes that the supply of goods determines how much output is produced. total output grows at rate ______ and output per workers grows at rate ______. requires initially increasing consumption to decrease consumption in the future. In the Solow growth model. the Solow growth model: assumes that the factors of production and technology are the sources of the economy's output.0 0. A) B) C) D) increase. According to the Solow growth model. A) B) C) D) Unlike the long-run classical model in Chapter 3. the capital per worker will ______ and output per worker will ______ until the steady state is attained. a higher . decrease decrease. * * * * * * 5.0 0.f(k ) . produces higher consumption at all times in the future. 9. c = k . increase increase. describes changes in the economy over time. if population grows at rate n. requires initially reducing consumption to increase consumption in the future. A) B) C) D) When an economy begins below the Golden Rule. reaching the Golden Rule: produces lower consumption at all times in the future. increase 8. Use the simple Solow model. Assume two economies are identical in every way except that one has a higher saving rate. if investment exceeds depreciation. the same the same. is static. In the Solow growth model of an economy with population growth but no technological change. with no population growth. in the steady state the country with the higher saving rate will have ______ level of total output and ______ rate of growth of output per worker as/than the country with the lower saving rate. A) B) C) D) n. A) B) the same.n 7. decrease decrease.n n. 6.

the higher the distance from the steady state. (See question 1. What are the growth rates of the variables of interest? For example. the rate of technological progress. a policymaker must determine the steady-state saving rate that produces the: A) B) C) D) largest MPK. THE SOLOW DIAGRAM WILL REMAIN THE SAME!! The only thing that will be affected immediately is the value of capital per worker. and analytically). largest output per worker. Be careful with the type of change that we study. if we say that the population growth decreases. For example. if we say that population decreases. capital per worker and output per worker are not constant in the steady state. due to a war or a natural disaster. the higher the growth rates of capital per worker and output per worker (See question 2). (See question 3) • • • What happens with the growth rates during the transition from one steady state to another? (This is also known as short run effect or temporary effect). in the Solow model with technological progress. However. smallest depreciation rate. a higher 10. the (d + n + g)k line will shift downwards. (See question 1) As we have seen.C) D) a higher. the same a higher. you have to use an analysis similar with the example of the Japanese economy that we covered in class. 3) . they both grow at rate g. (See the question that we did in the Solow model that I have also posted in the class’ web page). In this case. largest consumption per worker. Problems • • Make sure that you know how to study a growth model (both graphically. To determine whether an economy is operating at its Golden Rule level of capital stock.

since L decreases. k will increase to k0. at k0: (d+n)k 0 > sf(k 0) Recall also. with saving rate s. This means that the graph will remain the same. and K is constant.2 k* 0.4 0.(d+n)k Combining the two relations shows that the level of k will start to decrease.8 y* 0.4 sf(k) 0.2 0 0. Due to a natural disaster. note that we have a decrease in population. Assume that an economy is at the steady state.6 (d+n)k 0.8 1 The economy is initially at the steady state (k ). the only thing that is affected is the level of capital per worker. Graphically. not in its growth rate. that ? k = sf(k) .6 k0 0. Specifically. while the level of capital remains the same. Moreover.1. Notice that all the curves in the graph remain unchanged! * The immediate effect of the disaster is an increase in the level of capital per worker. Since L decreases. the capital per worker (K/L) will increase. depreciation rate d. . there is a big decrease in the population. and growth rate of population n. What would be the short run effect of this disaster? What would be the long run effect? -----------------------------------------------------First. 1 f(k) y0 0.

k will decrease.Based on the above. a Marsian economist issues the following statement: “The inferiority of your species resulted to your defeat! We won the war.2 ~ kB ~ k* 0. say * ~ k* . k and y are constant and their growth rates are zero. k and y will decrease.6 ~ (d+n+g) k 0. For the moment. − Once the level of k drops at k . After the end of the war. the economy experiences a negative growth rate of k . The year is 2130. is the Marsian economist correct? -------------------------------------------------------------First. we don’t know which one is for Earth and which is for Mars. At the new level of k . At this level. since our economy grows now much faster than yours!” Based on the Solow model (with technological progress). i. ? k<0. L and E remained the same). Earth and Mars are identical (!) and they are both in the same steady state. the capital of both countries decreased.4 ~ sf( k ) 0. So.8 0. The war finishes at 2131 and both countries have lost significant part of their capital (however.8 1 . it will have a negative growth rate. Due to the war. the effects of a decrease in the population is: − − Initially. note that both planets start at the same steady state.6 0. Mars declares war against Earth. 2. and that’s clear.e. At that time. The same happens with y.e.2 0 ~ kA 0. the economy is at its old steady state. savings are lower than the level of (d+n)k . in the short run (or in the transition period). i. 1 ~ k are ~ f( k ) 0. the same will happen with y.4 0. Suppose that the new values of ~ ~ k A and k B . which implies a negative growth rate. As a result. As k decreases. k . * To summarize. the level of k will increase. This will continue till we reach the initial steady state.

In other words. they are operating at ~ kA . ---------------------------------------------------- Suppose that the savings rate increases from s0 to s1. Graphically. capital per worker and output per worker are never constant. Moreover. the Marsian economist is wrong! 3. they didn’t win. we get 1 ~ f( k ) 0. the economy that operates at ~ kA will grow faster than the one operating at point ~ k B . When we are below the steady state. Since ~ kA < ~ kB (and L.8 0. Since Mars grows now faster.4 ~ (d+n+g) k ~ s1 f( k ) ~ s0 f( k ) ~ k * 0.2 0 0. Mars lost more capital than Earth. Based on that. the higher the distance from the steady state. Hence.1 0. suppose that the economy is at the steady state when s increases.e. i.4 0.2 0. This means that they suffer more losses during the war.3 ~ k '* 0. the higher the growth rate of capital per worker and output per worker. their growth rate is higher. E have not change). Specifically.6 0. it follows that KMARS < KEARTH .In the Solow model with technological progress. In the steady state. they both grow at rate g. What will be the short run and long run effects of an increase in the rate of savings? Use the Solow model with population growth n and rate of technological progress g.5 .

Recall also.e. when the new steady state is reached. To summarize: In the initial steady state. the following effects emerge: ~ ~ ~ ~ ~ 1. As a result. will be greater than g.e. Y/L and K/L will grow at the rate of technological progress. Y. Y/L. s0 f( k )>(d+n+g) k . it has a positive growth ~ K ~ rate. The ~ only “permanent” effect will be the increase in k and ~ . At k = k * . Finally. 2. y . K/L.e. K/L and Y/L will grow faster.e. that k = . g. K/L and Y/L will again grow at rate g.Initially. K. LE ~ In other words Growth rate of K > n + g Based on that. with a rate greater than g. K/L and Y/L will grow faster than usually. it follows that K grows faster than LE. K/L and Y/L grow at rate g During the transition period. Since k increases. i. k increases. i. At the time that s increases. The same will be the effect for the growth rate of output per worker. the economy operates at k * . during the transition to the new steady state. the growth rate of capital per worker. To summarize. i. Once we reach the new steady state. i.

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