Question

Consider the Solow model, presented in chapter 7. Suppose that the economy is initially in a steady state and that some of the nation’s capital stock is destroyed because of a natural disaster or a war. (a) Determine the long-run effects of this on the quantity of capital per worker and on output per worker.

Answer 1

Output per Worker will fall. Then, Net Investment will increase & steady state will be resumed.

Step-by-step explanation:

As per Solows model : Output or income per worker depends on capital stock per worker.

Output per worker is directly related to capital per worker : more capital per worker implies more output per worker & vice versa. So, output per worker curve is upward sloping, dependent on capital per worker. However, output per worker rises at a diminishing rate with capital per worker. So, it is a swamp shaped curve.

Solow model steady state is where : constant proportion of this 'income per worker' saved & invested = constant depreciation of the existing capital stock.

Disaster or war reducing capital per worker : reduces the output per worker also [as they are directly related]. This denotes the state before the steady state. Here, saving (gross investment) per worker is more than depreciation of the existing capital stock. So, there will be net addition to capital stock. Capital stock & output per worker would increase, proceeding towards steady rate.