Question

If the marginal product of capital net depreciation equals 8 percent, the rate of growth of population equals 2 percent, and the rate of labor-augmenting technical progress equals 2 percent, to reach the Golden Rule level of the capital stock, the ____ rate in this economy must be _____.

Answer 1

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If the marginal product of capital net depreciation equals 8 percent, the rate of growth of population equals 2 percent, and the rate of labor-augmenting technical progress equals 2 percent, to reach the Golden Rule level of the capital stock, the ____ rate in this economy must be _____.      

A) saving; increased  

B) population growth; decreased

C) depreciation; decreased

D) total output growth; decreased

Answer

The correct answer is  A) Saving rate of the economy must be increased in order for the economy to reach the Golden Rule Level of the Capital Stock.

Explanation

Golden Rule Level of the Capital Stock is the level at which

MPK = δ,

Where MPK is Marginal Product; and δ the depreciation rate;

so that the marginal product of capital equals the depreciation rate.

In the Solow growth model, a high saving rate results in a large steady-state capital stock and a high level of steady-state output. A low saving rate results to a small steady state capital stock and a low level of steady-state output. Higher saving leads to faster economic growth only in the short run. An increase in the saving rate raises growth until the economy reaches the new steady state. That is, if the economy retains a high saving rate, it will also maintain a large capital stock and a high level of output, but it will not maintain a high rate of growth forever .