Reference no: EM131868612

Suppose a hypothetical economy can be well represented by a Solow model. The production function is estimated to be Y=(K^0.5)(L^0.5), where Y represents output, K is capital and L is labour. We know that the speed of output growth (and capital growth) per worker declines as output per work increases towards its steady state. This is generally true in the Solow model and reects that fact that there are diminishing returns to capital: as k increases, the increments to output and, hence, to changes in the future capital stock per worker, k, proportionally decline.

Question: Suppose outside donors agree to provide an amount of aid every year which effectively matches the investment made by domestic citizens. Assuming all of this aid is invested each year, how will this affect the steady state income per capita? How will it affect the long run growth rate?