In the solow growth model, suppose initially that the economy is in its steady state, in which the saving rate is lower than the golden rule saving rate. Suppose saving rate is changed to the golden rule saving rate. With aid of diagram explain the effect of that change on consumption

Answer 1

The Solow growth model is an economic model of long-run economic growth that analyzes how economic output is determined by population growth, capital accumulation, and technological progress.

In the Solow growth model, the golden rule saving rate is the optimal saving rate that maximizes the steady-state level of consumption per capita. If the initial saving rate is lower than the golden rule saving rate, then the economy is not in its optimal steady state.

When the saving rate is changed to the golden rule saving rate, the economy will move from its initial steady state to a new steady state with a higher level of consumption per capita. This is illustrated in the diagram below.

The initial steady state is represented by point A, where the saving rate is lower than the golden rule saving rate. When the saving rate is changed to the golden rule saving rate, the economy moves to a new steady state at point B, where the saving rate is equal to the golden rule saving rate and the level of consumption per capita is higher than at point A.

Thus, when the saving rate is changed to the golden rule saving rate, the effect on consumption is an increase in the level of consumption per capita.