Assignment-3 Emaan Shahid

L180366

What is the difference between steady state and golden rule level of capital?

The steady state of capital and the golden rule level of capital are not different but are related to one
another. The steady state of capital is the point where capital per worker is not changing, meaning all
investment goes to offset depreciation and there is no economic growth. The golden rule is the point at
the steady state with the maximum consumption per worker.

What is the condition for the economy to maximize consumption?

For an economy to maximize consumption, it should be at the steady state where the difference
between output and depreciation is maximum. This point is called the golden level of consumption.

Golden rule steady state:

Previously, from the Solow growth model, we have already established that

c=y+i

Where “c” is the consumption per worker, “y” is the output per worker and “I” is the investment per
worker. Therefore, this means that consumption is equal to output minus investment.

Steady State Values:

“y” in the steady state is equal to f(k*). Investment “i” is equal to depreciation “dk*” in the steady state
as the capital stock remains unchanged. Thereby, the above-mentioned equation can be written as:

c* = f(k*) - dk* (After paying depreciation from your output, the residual output is your consumption.)

Graphically:

The steady state consumption “c*” is the difference

between output and depreciation per worker. The point
where the steady state consumption is maximized is called
the golden rule steady state.

 The golden level of consumption is denoted by c* gold.

 The golden level of capital is denoted by k* gold.

To the left of golden rule of steady state, increases in

capital stock increases steady state consumption. To
the right of golden rule of steady state, increase in
capital stock reduces consumption.

At golden level of capital (denoted by k* gold,) the slopes of

depreciation “dk*” and output “f(k*)” are equal. At this point consumption is maximum.
 Assignment-3 Emaan Shahid
L180366

Discuss the role of saving in the Solow growth model.

 In an economy, if the savings increase, capital stock

increases and steady state output will also increase to a
new level.
 If the savings decrease, capital stock and steady state
output will also decrease.

Relationship Between Savings and Economic Growth:

Higher savings will lead to higher capital stock and faster economic growth. This growth continues until a
new steady state is achieved in an economy. However, an economy cannot maintain a high rate of
economic growth indefinitely. This is due to policies leading towards the growth effect. As the level of
income per person is said to be influence by the saving rate and not by the growth rate, therefore,
higher savings have a level effect.