Macroeconomics:
1. Read “Growth: Illusions and Realities,” the chapter of Capital in the Twenty-First Century by Thomas Piketty. The chapter will be available on the class website. You do not need to submit any based on the reading, but it is required materials.
A simplified Solow Growth Model
1. Solow model as we have specified in our class: write down 5 endogenous variables, 5 equations, and exogenous variables/parameters of the Solow model. Show and explain how the system of five equations can be reduced into one equation in understanding economic growth in this model economy.
2. Solow model as we have specified in our class: suppose the level of TFP in an economy rises permanently, one time, from to:
a. Assume that the economy starts in its initial steady state. Analyze this change using a Solow diagram. Be sure you include an output graph in the diagram. Explain the process in words as well (be detail).
b. Show graphically (in ratio scale) what happens to the output per person in this economy over time as well. (Put output per person on the vertical axis, and time on the horizontal axis.) Explain in words as well.
c. Show graphically what happens to the growth rate of output per person in this economy over time. (Put growth rate on the vertical axis, and time on the horizontal axis.) Explain in words as well.
d. How is the response of the economy to an increase in TFP different from the economy’s response to an increase in the saving rate? (Hint: Think about what happens to consumption.)
e. Suppose that grew at a constant rate, instead of being constant. Explain in “words” what should happen to output over time.
3. What happens with no diminishing returns? Consider a Solow model where the production function no longer exhibits diminishing returns to capital accumulation. More specifically assume that the production function is now
a. Draw the Slow diagram in this case.
b. Suppose the economy begins with a certain level of capital stock (precise level does not matter). Show how the economy evolves in the Solow diagram. Be sure you include an output graph in the diagram.
c. What happens to the growth rate of per capita GDP? Does it cease to exist or not? Explain in words.