Recently a coup occurs in Turkey, a developing country where the steady state eq
ID: 1228150 • Letter: R
Question
Recently a coup occurs in Turkey, a developing country where the steady state equals to the golden rule initially. Due to the political instability, the birth rate in Turkey falls slightly and the emigrant rate jumps slightly, resulting in a lower dilution rate. Even firms which still operate in the country (including McDonald's, Pizza Hut and KFC, etc.) become conservative and thus decrease the investment rate dramatically. Also, during the coup huge amounts of existing factories are destroyed and machines are stolen by anarchists. The coup causes 3ome death as well. Assume all other factors including technology and depreciation rate keep unchanged. What happened to the per worker productivity in Turkey? What happened to the steady state per work capital level in Turkey? What happened to the golden rule per work capital level in Turkey and what happened to the maximal possible sustainable consumption level? Does your answer to (2) and (3) contradictory with each other? Why?Explanation / Answer
When a economy in a steady state equals the golden rule, it means that the economy is at a level of capital labor ratio that maximizes consumption per worker.
1. In the case of Turkey due to the political instability the birth rate in the country falls and also the emigrant rate jumps, which implies that there is a decrease in labor supply along with decrease in Investments. If we look at the production function below:
Y/Y = L/L +K/K + A/A
The production function shows the basic relationship between changes in output due to a changes in inputs of capital and labor and technological improvements. The relationship between inputs and output, for a given state of technology, is summarized in the production function, which can be written as:
Y = AF(K, L)
which implies that there is a positive relationship between output growth and growth in labor supply and capital. In the case of Turkey the Productivity would decrease due to a decrease in Labor growth and Capital.
2. In this case the capital-output ratio in Turkey is less than the golden rule.
3. If an economy begins at a steady state with a higher capital-output ratio than the golden rule steady state, then consumption per worker can be increased by reducing the savings rate. A decline in the savings rate will boost the steady-state level of consumption per worker, and thus increase consumption per worker in the long run. Moreover, by reducing savings and increasing the funds for consumption, consumption per worker can be increased in the short run as well. If the economy makes it start at a steady state with a lower capital-output ratio than in the golden rule, then the government must take necessary measures to raise the savings rate in order to reach the golden rule steady state. In the long run, this increase in the savings rate will lead to an increase in the steady-state level of consumption per worker, and thus increase consumption per worker in the long run.
However, the increase in the savings rate reduces the funds available for consumption in the short run. When the economy begins above the golden rule, reaching the golden rule produces higher consumption at all moments in time. But when the economy begins below the golden rule, reaching the golden rule requires reducing the level of consumption now and in the near future in order to boost consumption in the long run.
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