Question

Suppose an economy is initially in a steady state with capital per worker below the Golden Rule level.

If the saving rate increases to a rate consistent with the Golden Rule, then in the transition to the new steady-state consumption per worker will:

A) always exceed the initial level.
B) first fall below then rise above the initial level.
C) first rise above then fall below the initial level.
D) always be lower than the initial level.

Answer 1

B) first fall below then rise above the initial level.

Step-by-step explanation:

'Steady State' & 'Golden Rule' of capital per worker : are concepts of Solow model.

The model defines output (income) per worker as a function of capital per worker, increasing with it at a diminishing rate, & hence the curve is upward sloping swamp shaped. Depreciation is a constant slope straight upward sloping line. Saving is a function of income per worker.

• Steady State level is the level of output at which savings (investment) by workers is equal to depreciation of capital stock.
• Golden rule capital level refers to the saving rate, which maximises steady state level or growth of consumption.

If the saving rate increases to a rate consistent with the Golden Rule: the consumption per worker will first fall below the initial level (as savings proportion out of income are more). But, when these savings will be invested back, capital per worker will increase. High capital per worker will imply high output & income per worker. And, then the consumption per worker will rise.