Suppose that the economy grows by 4 percent, total factor productivity grows by 3 percent, and the labor force increases by 6 percent. If labor and capital are the only inputs and labor contributes 40 percent to GDP, then the stock of capital must have
A) fallen by 5 percent.
B) fallen by 3 percent.
C) fallen by 2 1/3 percent.
D) risen by 3 percent.
E) risen by 7 percent.

Question

Quizplus · Accepted Answer

Using the Solow growth model, the growth rate of GDP is the sum of the growth rates of total factor productivity, labor, and capital, weighted by their respective contributions to GDP. Given that labor contributes 40%, capital contributes 60%. The equation is: 4% = 3% + 0.4(6%) + 0.6(K). Solving for K gives a decrease of 2 1/3 percent.

Suppose That the Economy Grows by 4 Percent, Total Factor