Question

5. Foreign aid: Consider a Solow economy that begins with a cap to $300 billion, and suppose its steady-state level of capital is 1o its pleasant surprise, the economy receives a generous gift of foreign aru in the form of $100 billion worth of capital (electric power plants, machine tools, etc.). (a) Use the Solow diagram, other graphs, and the mathematics of the Solow model to explain what happens to the economy, both immediately and over time. By what proportion does consumption per person initially increase? What happens to consumption in the long run? (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) for this case.

Answer 1

Solution Page No : 1 I am " assuming de 33 exting to you have solved those findings part I am a and b. so answering Pool C) us This growth that exercise tells model: in our simple solou the the Foreign aid donations have no long Jun ezzect on the economy , since they don't change the steady state of economy as seen in part a. However, there are two Short-term ezzects to speed up movement towards e Steady State and to temporarily increase output per capita. Foreign aid is helpful if a country is below 10 Steady state as seen in part b; because it reduces the time of the economy to reach the steady State of speeds up the process. However, if a country is already at its steady state, a gift of foreign capital causes depreciation to exceed total investment, and the economy's. so in order to get a long-term increase in output per person, countries would have to after something other than their amount of capital , such as total factor productivity (A) or as we say technological innovations.