Question 4:

a. Identify two assumptions of the basic Solow Growth Model. (2 marks)

b. Why are these assumptions important in supporting the Solow Model? (4 marks)

c. You are given the following information about an economy.

Y = C + I

Y = F(K, L)

The aggregate production function for this economy exhibits constant returns to scale and

the marginal products of labor and capital are both subject to diminishing returns.

s = saving rate (assume this is constant) per year

= depreciation rate (assume this is a constant) per year

y = Y/L

k = K/L

k* = steady state of capital per worker (K/L) and sf(k) < k.

i. What is sf(k)?

ii. What is k?

iii. Interpret the meaning of sf(k) < k? (2mark)

iv. Graphically illustrate sf(k), k, and k*. Indicate on your graph where sf(k) < k.

(4marks)

v. Explain what happens in this economy when sf(k) < k. (2marks)