ECON8069 - Tutorial 9, Week 10
1. Using the Solow-Swan model discussed in lectures, and assuming the country starts
at the steady-state level of capital and output:
a) Suppose a war destroys large amounts of physical capital in the society. De-
scribe the evolution of capital over time following this event.
b) True, False, or Uncertain: In order to increase the rate at which the economy
returns to the steady-state following the war, the government should enact
policies to increase the savings rate in the short term.
2. Foreign Aid and Poverty Traps
a) Using the Solow-Swan model discussed in lectures, explain why foreign aid
of developed countries give capital to developing countries, may not lead to
sustained economic growth.
b) Some development economists believe the production function given in in Fig-
ure 1 is more representative of real-world production functions. Given produc-
tion as in Figure 1, find all steady-state equilibria. That is, find the levels of
capital per capita under which capital per capita does not change going into
the next period.
c) A steady-state is stable if the dynamics of the model mean that small deviations
from the steady-state will push the economy back to the steady-state. The
steady-state is unstable if it is not stable.
For each steady-state identified in part (b), identify whether that steady-state
is stable, or unstable.
d) Call an economy which is producing at the lowest positive steady-state in
Figure 1 in a Poverty Trap. True, False, or Uncertain: An economy in a
poverty trap has no long-run benefit from small amounts of foreign aid, but
may benefit in the long-run from a single large injection of foreign aid.
3. Consider the ‘Country Data’ in Table 1. Break into groups to discuss the following
question for one of these countries. Your tutor will assign the country to your
group, so you will need to have thought a little about each of the countries before
the tutorial.
What factors or policies should the government consider to increase GDP growth
in your given country?
1
sy∗
y∗
δk
k
y
Poverty Trap Production
Figure 1: Production Function with a Poverty Trap
GDP Population
GDP per
capita
P. School
Enrolment
Life
Expect.
GDP
Growth
Poverty
Ratio
FDI
A 18.05b 15.6m $1157 117% 68 7.1% 17.7% 1.7b
B 1.34t 23.8m $56302 106% 82 2.7% 5% 38b
C 66.7b 31.3m $2130 102% 68 8.1% 14.1% 1b
D 21.1b 16.2m $1302 103% 61 5% 60.5% 1.6b
Table 1: Country Data
N.B. Primary School Enrolment takes the number of students enrolled in primary school-
ing, divided by the number of people of primary school age. This number may be greater
than 100% due to students starting schooling early, or finishing late.