In the Solow model, what effect does an increase in the depreciation rate have on the steady-state capital stock? A. It decreases the steady-state capital stock B. It increases the steady-state capital stock C. It has no effect on the steady-state capital stock D. It depends on the initial level of capital stock
Question
In the Solow model, what effect does an increase in the depreciation rate have on the steady-state capital stock? A. It decreases the steady-state capital stock B. It increases the steady-state capital stock C. It has no effect on the steady-state capital stock D. It depends on the initial level of capital stock
Solution
A. It decreases the steady-state capital stock.
Here's why:
In the Solow model, the steady-state capital stock is the point where investment equals depreciation. If the depreciation rate increases, then for any given level of capital stock, the amount of capital that depreciates (or wears out) in a given period increases.
To maintain the same level of capital stock, investment would need to increase to match this higher rate of depreciation. If investment does not increase, the capital stock will decrease until it reaches a new steady-state where investment equals this higher rate of depreciation.
Therefore, an increase in the depreciation rate decreases the steady-state capital stock, all else being equal.
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