At the current steady state capital- labour ratio, assume that the steady state level of per capita consumption, (C/N)*, is less than the golden rule level of steady state per capita consumption. Given this information, we can be certain that:
A) An increase in the saving rate will cause an increase in the steady state level of per capita consumption ((C/N)*).
B) A decrease in the capital- labour ratio will cause a decrease in (C/N)*.
C) The capital- labour ratio will tend to increase over time.
D) A decrease in the saving rate will have an ambiguous effect on (C/N)*.
E) The capital- labour ratio will tend to decrease over time.

Question

Quizplus · Accepted Answer

The fact that the steady state level of per capita consumption is less than the golden rule level of steady state per capita consumption means that the economy is undersaving. Therefore, a decrease in the saving rate will likely worsen the situation and lead to a decrease in (C/N)*. However, an increase in the saving rate may or may not lead to an increase in (C/N)*, as it will depend on the speed at which the capital stock grows relative to the labor force. Therefore, D is the only certain choice.

At the Current Steady State Capital- Labour Ratio, Assume That