Immediately following the increase in the saving rate, output grows rapidly. As the economy approaches its new steady state:
A) the growth rate gradually increases
B) the growth rate gradually declines
C) the growth rate is constant
D) the growth rate is negative
E) None of these answers are correct.

Question

Quizplus · Accepted Answer

When the saving rate increases, investment also increases and this causes an increase in the capital stock of the economy. As a result, output grows rapidly, but over time as the economy approaches its new steady state, the growth rate gradually declines. This is because as the capital stock approaches its new steady state level, the returns to investment start to diminish, which in turn reduces the growth in output. Therefore, the growth rate gradually declines towards the new steady state level.

Immediately Following the Increase in the Saving Rate, Output Grows