Question

At the current steady state capital-labor ratio, assume that the steady state level of per capita consumption, (C/N)*, is greater than the golden rule level of steady state per capita consumption. Given this information, we can be certain that...A. an increase in the capital-labor ratio will cause an increase in (C/N)*B. the capital labor ratio will tend to increase over timeC. a reduction in the saving rate will have an ambiguous effect on (C/N)*D. the capital labor ratio will tend to decrease over timeE. a reduction in the saving rate will cause a decrease in the steady state level of per capita consumption ((C/N)*)

Answer 1

C) a reduction in the saving rate will have an ambiguous effect on (C/N)*

Step-by-step explanation:

The steady state consumption refers to the difference between how capital wears out or depreciates vs total output. In order to keep a steady state consumption, the savings rate (which equals investment) must be enough to replace any worn out or completely depreciated capital.

Since the consumption rate is already higher than the steady state consumption, the effect of a decrease in the savings rate is ambiguous. Every dollar earned by a household is either spent or saved, and in order for savings to decrease, spending must increase.

But in this case, the spending level is already too high. A decrease in savings should increase consumption but the effects of the increase in the capital labor ratio and the per capita consumption are not certain.