# Economic Growth 1. Consider a Solow economy without population growth as described in Chapter 8 of Mankiw, but let the specific production technologv be described by YAK1/3[2/3. Suppose it begins with a capital stock equal to $300 billion, and suppose its steady-state level of capital is equal to$500 b the form of $100 billion worth of capital (electric power plants, machine tools, etc.) illion. To its pleasant surprise, the economy receives a generous gift of foreign aid in (a) What happens to the economy immediately? What happens over time? By what pro- ortion does consumption per person initially increase? What happens to consumption in the long run! There is an immediate rise of K to$400 billion. Since it is now closer to the steady state, the economy and capital stock will grow more slowly than before. Consumption increases by the ratio (400 /30011/3, or 10%. Long-run consumption won't change at all (b) Suppose instead of starting below its steady-state, the economy begins in steady-state, with a capital stock equal to \$500 billion. Answer part (a) in this case . Consumption immediately increases by 1600/ 5001 = 3 = 6.3% and then starts de- clining. In the long run, nothing changes

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Solow Growth Model

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