Question

Starting from steady state, a permanent increase in the rate of depreciation in the Solow model causesa. the growth rate of output to fall temporarily but leaves the level of GDP unchanged in the long run.b. the growth rate of output to rise temporarily and the level of GDP to rise permanently.c. the growth rate of output to rise temporarily but leaves the level of GDP unchanged in the long run.d. the growth rate of output to fall temporarily and the level of GDP to fall permanently.

Answer 1

Answer:

The correct answer is option d.

Explanation:

Starting from steady-state, a permanent increase in the rate of depreciation in the Solow model causes the growth rate of output to fall temporarily and the level of GDP to fall permanently.

An increase in the depreciation rate will cause the depreciation curve to shift upwards. This upward movement in the depreciation curve will further result in a new lower steady state.  

The growth rate of output thus will rapidly be negative at first and then converge to zero as it approaches a steady state. The level of GDP will thus fall permanently.