In the Solow growth model, if investment exceeds depreciation, the capital stock will and output will until the steady state is attained. a. increase; increase b. increase; decrease c. decrease; decrease d. decrease; increase
The correct answer and explanation is:
The correct answer is: a. increase; increase
Explanation:
In the Solow growth model, the dynamics of capital accumulation play a crucial role in the determination of long-run economic output. The model focuses on the relationship between the capital stock, output, and investment.
- Investment exceeds depreciation:
When investment is greater than depreciation, it means that more resources are being directed toward maintaining and expanding the capital stock than are being used up due to depreciation. Depreciation represents the wear and tear on existing capital, and investment reflects the addition of new capital to the economy. In this case, the net addition to the capital stock is positive, causing the capital stock to increase over time. - Capital accumulation and output growth:
As the capital stock increases, this results in a larger productive capacity of the economy. With more capital available for production, output also tends to increase. The Solow model assumes that output is a function of capital and labor, and as capital increases, output increases as well, but at a diminishing rate due to diminishing returns to capital. - Approaching the steady state:
In the long run, as capital continues to accumulate, the economy will approach a steady state. At this point, investment exactly equals depreciation, and the capital stock stabilizes. However, during the transition towards the steady state, as long as investment exceeds depreciation, both capital and output will increase. Once the steady state is reached, the capital stock and output stop growing, unless there are changes in factors like technological progress or population growth.
In summary, when investment exceeds depreciation in the Solow model, capital stock will increase, and as a result, output will also increase until the steady state is attained.