Chapter 3

Physical Capital
Solutions to Problems

1. To find the steady-state value of the country, we refer Equation 3.3 on page 64.

α
 γ  1−α
1

y ss = A 1−α
  .
δ 

Plugging in values: A = 1, α = 0.5 , γ = 0.5, and δ = 0.05, we get:

0.5
1
 0.5  1−0.5
y ss = 1
1− 0.5
  .
 0.05 

Simplifying the above equation, we get yss = 10.

To find the current output per worker, we substitute in k=400 into the production
function to get:
1 1
y = k 2 = 400 2 = 20.

That is, the current output is 20 whereas the steady-state output level is 10. Therefore,
we conclude that y > yss and so the country is above its steady-state level of output per
worker.

2. In the diagram below, we have the determination of the steady-state wolf

population, with the Y-axis representing rates of birth and death for wolves and the X-axis
representing the population of wolves.

8
 Chapter 3 Physical Capital ™ 9

The “Death Rate of Wolves” curve is given by the upward sloping line, where large wolf
populations correspond to higher death rates. The intuition is that larger wolf populations
require more resources for survival and smaller wolf populations require fewer resources
for survival, leading to higher death rates when these resources are strained and vice
versa. The “Birth Rate of Wolves” curve is given by the horizontal line because birth
rates are considered to be constant. The steady-state value is given by the intersection.
To the right of the intersection, the death rate is higher than the birth rate, resulting in a
decline in the wolf population. Similarly, to the left of the intersection, the death rate is
lower than the birth rate, resulting in an increase in the wolf population. At the
intersection, the birth rate equals that of the death rate, resulting in a stable wolf
population. As an extension, if the model were shocked by an exogenous increase in
resources, such as a larger deer population, the “Death Rate of Wolves” curve would shift
down. For every current wolf population, the increase in resources lowers the death rate.
Similarly, if wolves became more fertile and increased the birth rate, the “Birth Rate of
Wolves” curve would shift upward. In each case, we would have a new steady-state wolf
population.

3. Denoting each variable by the appropriate country subscript, we write Equation

3.3 from page 64 in ratio form. That is,

α
1 γi  1−α
Ai 1−α  
y i , ss
= δi  .
α
y j , ss
1 γ  1−α
A j 1−α  
j
δ 
 j 

Since productivity, A, and depreciation, δ , are the same, we can cancel them and rewrite
the previous ratio with the appropriate values: γ 1 = 0.05, γ 2 = 0.2 and setting α = 1/3.

1
α 3
y1, ss γ  1−α
 0.05 
= (0.25) 2 = 0.5.
1 1
=  1  = 
1−
3
y 2, ss γ 2   0 .2 

For α = 1/2, we get,

1
α 2
y1, ss γ  1−α
 0.05 
= (0.25) = 0.25.
1
=  1  = 
1− 1
2
y 2, ss γ 2   0 .2 

Therefore, when α = 1/3, the ratio is 0.5 or 1 to 2 and when α = 1/2, the ratio is 0.25 or 1
to 4.
10 ™ Weil Economic Growth

4. Since we know productivity, A, and depreciation, δ , are the same, we know that
they will cancel out in our steady state ratio analysis. Therefore, with α =1/3, our
equation of interest boils down to
α 1
y1, ss  γ  1−α  γ 1  2
=  1  =   ,
y 2, ss γ 2  γ 2 

for all three pairs of countries.

(a) Using a subscript T for Thailand and a subscript B for Bolivia, we rewrite the
previous equation for Thailand and Bolivia as,

1
yT , ss γ 2
=  T  .
y B , ss γ B 

Substituting in γ T = 0.294 and γ B = 0.101, we get the steady state ratio to be:

1
yT , ss  0.294  2
=  ≈ 1.71.
y B , ss  0.101 
The actual ratio is,

yT  $12,086 
=  ≈ 1.69.
y B  $7,152 

Therefore, the Solow Model does a good job in predicting relative income for Thailand
and Bolivia.

(b) Using a subscript N for Nigeria and a subscript T for Turkey, we rewrite the
previous equation, with γ N = 0.075 and γ T = 0.149 to get,

1 1
y N , ss γ  2  0.075  2
=  N  =   ≈ 0.71.
yT , ss γT   0.149 

The actual ratio is,

y N  $1,906 
=  ≈ 0.12.
yT  $15,726 

Therefore, the Solow Model does a poor job in predicting relative income for Nigeria and
Turkey.
 Chapter 3 Physical Capital ™ 11

(c) Using a subscript J for Japan and a subscript N for New Zealand, we rewrite the
previous equation, with γ J = 0.311 and γ N = 0.21 to get,

1 1
γ 
 = 
y J , ss 2 0.311  2
=  J  ≈ 1.22.
y N , ss γ N   0.21 

The actual ratio is,

y J  $69,235 
=  ≈ 1.72.
y N  $40,176 

Therefore, the Solow Model does a good job in predicting relative income for Japan and
New Zealand.

5. If output per worker is rising in Country X and output per worker is falling in
Country Y, we can be assured that both countries are not in their respective steady states.
Instead, they are converging to their respective steady states. In addition, for Country X
and Country Y, we are given information that depreciation, productivity and output per
worker are identical. By the process of elimination, the only difference between the
countries can and must be the level of capital stocks. Capital stock levels follow the
process:

∆k i = γ i f (k i ) − δ i k i .

As such, we can conclude that differences in investment rates are responsible for the
divergence in output per worker. Specifically, a rise in output per worker for Country X
and a fall in output per worker for Country Y imply that the ratio of steady-state output
per worker is,
α
y X , ss γ  1−α
> 1; therefore,  X  > 1; implying , γ X > γ Y .
yY , ss  γY 

Consequently, we can determine that Country X has a higher investment rate than that of
Country Y, and these differences account for the falling and rising levels of output per
worker.

6. (a) First we find the steady-state level of capital per worker. Using the values for
investment, γ =0.25 , depreciation, δ = 0.05, productivity, A=1, and α =0.5, we get,

1 1
 Aγ  1−α  (1)(0.25)  1−0.5
k ss =   =  = 5 2 = 25.
 δ   0.05 
12 ™ Weil Economic Growth

That is, the steady-state level of capital per worker is 25. Plugging in kss into the
production function we get the steady-state level of output per worker to be:

1 1
y ss = k ss 2 = (25) 2 = 5.

That is, the steady-state level of output per worker is 5.

(b) For year 2, using 16.2 as the value for capital per worker, calculate output, y,
followed by investment γ y, depreciation δ k, and then change in capital stock. Add the
value for change in capital stock to 16.2, the value for capital per worker in year 2, to get
capital per worker for year 3. Use year 3 capital to obtain all the values for year 3 and
continue up to year 8. The filled in table is below.

Year Capital Output Investment Depreciation Change in Capital Stock

1 16.00 4.00 1.00 0.08 0.20
2 16.20 4.02 1.01 0.81 0.20
3 16.40 4.05 1.01 0.82 0.19
4 16.59 4.07 1.02 0.83 0.19
5 16.78 4.10 1.02 0.84 0.19
6 16.96 4.12 1.03 0.85 0.18
7 17.14 4.14 1.04 0.86 0.18
8 17.32 4.16 1.04 0.87 0.17

(c) The growth rate of output between years 1 and 2 is given by:

y   4.02 
g =  2  − 1 =   − 1 = 0.005.
 y1   4 

That is, output per worker grew at a rate of 0.5 % between years 1 and 2. (Using exact
values, the growth rate is approximately 0.62 % for years 1 and 2.)

(d) The growth rate of output between years 7 and 8 is given by:

y   4.16 
g =  8  − 1 =   − 1 = 0.0048.
 y7   4.14 

That is, output per worker grew at a rate of 0.48 % between years 7 and 8. (Using exact
values, the growth rate is approximately 0.52 % for years 7 and 8.)

(e) The speed of growth has changed from 0.50 % to 0.48 % implying that growth
has slowed down at a rate of 4 %. Thus, as a country reaches their steady-state value, the
rate of growth slows.
 Chapter 3 Physical Capital ™ 13

7. Before beginning the analysis, we define two new variables. The level of capital
per worker, necessary to achieve consumption level c* is denoted k*. Technically, k* is
given by f −1 (c*) . Therefore, if the initial level of capital, ki is above k*, savings will be
positive, and if ki is below k*, savings will 0. The second variable I define is k (refer to
second figure). It is the level of capital at which depreciation is equal to savings and
distinct from the steady-state level of capital, if it exists. We are now ready to begin our
analysis. There are two cases.

Case 1. Depreciation is always greater than Saving; δk > γf (k ), ∀k

In the figure below, at any initial level of ki, depreciation is always greater than
savings. The level of capital falls over time, as does the level of income per worker.
Consequently, the economy will continue to stagnate until the level of income and the
capital stock are zero.

Case 2. Depreciation is not always greater than Saving; δk ≤ γf (k ), for some k

The figure below shows two possible scenarios. If the initial level of capital, ki, is
equal to or below k*, then savings in the economy will be zero. The level of capital in
the economy falls due to depreciation and we achieve the same result as in the first case.
On the other hand, if ki ≥ k , then the level of savings exceeds or will exceed the level of
depreciation and the capital stock rises over time. The capital stock will reach a state-
state value as will income. If xxxx, then the amount of savings does not exceed the
amount of depreciation. The level of capital stock begins to fall and we are in the first
case where both income and capital go to zero levels. In the end, the ultimate
determinant of where the economy rests is determined by the initial level of capital,
commensurate with the initial level of income.
14 ™ Weil Economic Growth

8. First, in a steady-state level that maximizes consumption per worker, the change
in capital stock will be zero. That is,

∆k = 0 = γf (k ) − δk .

Rearranging the previous equation, we know that investment must equal depreciation.

γf (k ) = δk .
Second, given that any output not saved is consumed, we can write an equation for
consumption as,

C = y − γf (k ) = A(k )α − δk .

In the last part of the previous equation, we replace savings with depreciation and write
output in functional form. In this form, we are able to take the derivative to find the
necessary condition that will guarantee consumption maximization. Taking the
derivative with respect to k and rearranging,

d d
C= A(k )α − δk = αA(k )α −1 − k .
dk dk

aA(k )α −1 = δ .
 Chapter 3 Physical Capital ™ 15

That is, the marginal product of capital must equal the rate of depreciation. Combining
the consumption maximization condition ( aA(k )α −1 = δ . ) with the steady-state condition
( γf (k ) = δk . ), we get:

saving = γy = γf (k ) = δk = αA(k )α −1 × k = αA(k )α = αf (k ) = αy.

Therefore, it is easy to see the γ must equal α by the above string of equalities. In any
steady-state level of consumption per worker, the investment/saving rate must equal the
value α .