14.

02Quiz3Solutions
Fall2004
Multiple-ChoiceQuestions
1) Accordingtothearticle,whatisthemainreasoninvestorsinUSgovernmentbonds
growlessoptimistic?
A) Theyareconcernedaboutthedecline(depreciation)ofthedollar,which,inthe
longrun,leadstoanincreaseinthepricelevel.
B) Theyareexpectinghighinflationduetorisingoilprices,whichwouldleadtoa
fallinrealinterestratesinthefuture,despitetheFedstightening.
C) BecausetheFedisintighteningmode,duetoreportsofhigherjobcreationand
evidenceoflowinflation,andthustheyexpectthepriceofbondstodecrease.
D) BecausetheFedisintighteningmode,duetoreportsofhigherjobcreationand
evidenceoflowinflation,andthustheyexpectthepriceofbondstoincrease.
E) BothA)andD).
Answer:C).TheinvestorsaregrowingmorebearishbecausetheFedislikelytokeep
raisinginterestratesdespitethedeclineofthedollar.Thefactthatjobcreationhas
pickedupandthatinflationisnotaproblematthemomentpointstothe
strengtheningoftheeconomy.So,thereisnoreasonfortheFedtostoptightening.
Whathappensifinterestratesrise?Weknowfromthetextbookchapteronvaluation
ofsecuritiesthatbondpricesareinverselyrelatedtointerestrates.Asinterestrates
increase,treasurieslosetheirvalue(theirpricesdecrease).Thismightseemgood
fromaperspectiveofabuyerofabond.Butrememberthatthetreasuriesinvestors
inthearticlesarealreadyholdingthesecurities!Obviously,theyarenothappy
aboutthedecreaseinthevalueoftheirholdings.
2) ThereportsaysthatABloombergNewssurveylastweekshowedthatmostexperts
expectedtheFedtoraisethetargetlevelforovernightloansbetweenbanksto2.25
percentfrom2percentonDec.14.Amonthago,onlyafewforecastanincreasein
thefederalfundsrate.Thisinformationimpliesthevaluationofanyassets(hint:use
theformulaforEPDVdiscussedinclassandassumenothingelsechangesinreaction
towhattheFeddoes):
A) WilldecreaseonDec.14iftheFedincreasesthetargetlevelto2.25percent.
B) WilldecreaseonDec.14iftheFedraisesthetargetlevelto2.50percent.
C) Havedecreasedfromlastmonthtotoday.
D) BothA)andC).
E) BothB)andC).
Answer:E).Visanegativefunctionofi
e
(t+s).Thereportsuggeststhati
e
has
increasedduringthelastmonthandisexpectedtoincreaseonDec.14,thereforeV
hasdecreasedduringthelastmonth(thus,optionC)iscorrect),iftheFedincreases
theinterestrateasexpectednothingelsewillchange(thereforeA)isnotcorrect).
AndiftheFedincreasestheinterestratebymorethanexpected,assetspriceswill
decreaseagain(thusB)isalsocorrect).Then,thecorrectanswerisE).
3) Thearticlereportsthatthedollarweakened3.9%againsttheeurooverthelastmonth.
Ifthedollarcontinuestoweaken,weshouldexpect(assumethattheMarshall-Lerner
conditionholds)
A) ExportsfromtheUStoEuropetoincrease.
B) USimportsfromEuropetoincrease.
C) TheUStradebalancewithEuropetodeteriorate.
D) BothA)andC).
E) BothB)andC).
Answer:A).ThedepreciatingdollarwillweakenthepurchasingpowerofUS
consumersvis--visEuropeangoods,whichwillleadtoadeclineinimports.TheUS
tradebalancewillimproveunderMarshall-Lernerconditionsasaresultofhigher
exportsandlowerimports.
4) ThearticlementionstheChinaScare,statingthatUSgovernmentbondsfellon
Nov.26afterChinaBusinessNewsreportedYuYongding,aChinesecentralbank
official,saidChinahadcutitsholdingsofU.S.debt.WhydidthepriceofUS
governmentbondsfallasareactiontothenewsfromChina?
A) ThedemandfordollarsdeclinedwhichhastoleadtoanincreaseincurrentUS
interestrates.
B) Thedemandfordollarsdeclinedwhichhastoleadtoanincreaseincurrentand
futureUSinterestrates.
C) USinterestratesareexpectedtorisetopreventtheUSfromrunninginto
problemswithfinancingitstradedeficit.
D) TheFedwillhavetoraiseinterestratestopreventtheUSgovernmentfrom
sellingitsbonds.
E) BankersinNewYorkwereworriedthatthereportwasactuallydistortedwhich
leadstouncertaintyaboutthetruedemandfordollars.
Answer:C).Whenacountryhasatradedeficit,itneedstoborrowfundsfromabroad
tofinancethisdeficit.ThefactthatChinaholdsU.S.governmentbondshelpsto
financetheU.S.tradedeficit.Forexample,theU.S.buysmoregoodsfromChina
thanChinabuysfromtheU.S.andthustransfersmoredollarstoChinathanthe
ChineseneedtobuyU.S.goods.Chinaacceptstheseadditionaldollarssincetheyuse
themtobuyU.S.governmentbonds(thatistheU.S.borrowsthismoneyfromChina
sincebondsarejustIOUs).IfChinasuddenlydecidesthatitwantstobuyfewerU.S.
governmentbonds,theU.S.wontbeabletoborrowasmuchfromChina,unlessthe
U.S.increasestheinterestrateongovernmentbonds.Increasingtheinterestrate
wouldmakeU.S.governmentbondsmoreattractiveasaninvestmentsincethey
wouldpayahigherreturn.
0000
A
LongQuestionI(35/100points)
OpenEconomyAS-ADandGrowth
Assumethattheeconomyisdescribedbythefollowingsetofequations.
Exchangerate: E= E
PriceSetting:P=(1+)

W
A

WageSetting:W=P
e
A
e
F(u,z)
AD: Y=C(Y,T)+I(Y,i)+G+NX(Y,Y*, )
AssumethattheMarshall-LearnerConditionissatisfied.
1. Supposetheeconomyisataplacewhereu<u
N
(pointQ). AssumethatAandA
e
areconstant.Withoutfiscalpolicyandmonetarypolicyinterventions,whathappens
overtime? Showgraphically.Labelallcurves.Labelthemedium-runequilibrium
i
YN
E E
i
M
IS
MR
Y
N
i
0
IS
0
Y
0
Q
LM
MR
aspointMclearly.
P
M
AS
MR
AD
0
Q
P
1
AS
0
P
0
Y
AtpointQ,Y
0
>Y
N
,sou
0
<u
N
. This
meansthattheeconomyisatalevel
thatisbeyonditscapacity. So,people
expectthepriceleveltoincreaseinthe
nearfuture. WhenP
e
increases,W
increasessincethewagesetting
relationtellsusthatW=P
e
A
e
F(u,z).
AnincreaseinWincreasesPsincethe
pricesettingrelationtellsusthatP=
(1+ )(W/A).AsPincreases,theAS
curveshiftstotheleftandup. Atthe
sametime,LMshiftsup,becausean
increaseinPdecreasestherealmoney
Y
N
Y
0
Y
A
00000
0000
supplyeventhoughtheFedisnotdecreasingnominalmoneysupply.Thisprocess
continuesuntiltheeconomyreachespointMwhichisthemedium-/long-run
equilibriumwhereY=Y
N
andu=u
N
.
2. Ifthecentralbankannouncesaone-timerevaluationofitscurrencythatiscredible,
whathappensovertime? Still,assumethatAandA
e
areconstant.Showgraphically.
Labelallcurves.Labelthemedium-runequilibriumaspointMclearly.
i
M
IS
MR
i
0
IS
0
Q
LM
MR
LM
1
LM
0
i
UIP
1
UIP
0
YN Y
N
Y
0
Y
E
1
E
0
E
Ifacountryhasacrediblefixed
exchangeratesystem,thenits
P
announcementofaone-time
revaluationisalsocredible. So,ifthe
centralbankannouncesaone-time
revaluationofitscurrency,itis
believedbytheinvestors. Credibility
meansthatinvestorsexpectthe
P
0
exchangerateofthiscountryto
decreaseandbefixedatitsnewlevel.
P
1
M
AD
MR
Q
AS
0
=
AS
MR
AD
0
So,E
e
decreasesbytheamountofthe
announcement. Thisshiftsthe
interest-rateparityconditioncurveto
Y
0
Y
theleft/down. Sincethecentralbank
hasnotchangedthenominalmoney
supply,todaysexchangerateincreasesto E
1
andi=i*.
Whentheexchangeratedecreases,netexports(NX)decreaseduetotheMarshall-
Lernercondition.ThismeansthattheIScurvewillshifttotheleft.Thisalsoshifts
theADcurvetotheleft,andPstartstofall.Inafixedexchangerateregime,
monetarypolicymustaccommodate.Thecentralbanknowmustdecreasethemoney
supplysothattheexchangeratedoesnotdeviatefrom E
1.
Noticethatthecentral
bankactuallydecreasesthemoneysupply,sothattheLMcurveshiftstoLM
1
,butthe
becauseofadecreaseinP,theLMcurveisLM
MR
inthemedium-/long-run. PointM
isthemedium-/long-runequilibrium.
3. Whatistheadvantageofgovernmentintervention,namelyone-timerevaluationof
thedomesticcurrencyinquestion2,ifthespeedofadjustmentfrompointQtothe
medium-runequilibriumwasthesameasinquestion1?Limityouranswerstoafew
sentences.
Themaindifferencebetweenthemedium-runequilibriumofquestion1and2isthe
equilibriumprice.Evenifthespeedofadjustmentisthesame(usuallytheadjustment
inquestion2isfaster),themedium-runequilibriumpriceishigherifthegovernment
(andthecentralbank)doesnotintervene.Thismeansthatinflationishigherunder
thescenarioinquestion1. Thisproblemofinflationdoesnotexistwithone-time
revaluation.
4. Now,theeconomyisatthemedium/long-runequilibrium(pointM)butit
experiencesanincreaseinproductivity. Whathappenstoitsnaturalrateof
unemploymentifpeoplesexpectationsaboutpricesandproductivityarecorrect?
Why?Showgraphically. Labelallcurves.
Whenthiseconomyexperiences
anincreaseinproductivity,
nothinghappenstoitsnaturalrate
ofunemployment. Thisisbecause
M
M
PS
0
WS
1
+ 1
1
A
+ 1
0
A
P
W
PS
1
boththePSscheduleandtheWS
scheduleshiftupbythesame
amount. Whybythesame
amount? Itisbecausepeoples
expectationsofproductivityare
equaltotheactualproductivity
improvement.TheWScurveshifts
WS
0
upbecauseanincreaseinA
e
increasesWandthisincreasesthe
u
1
N
realwage(W/P).ThePScurve
u
shiftsupbecauseanincreaseinA
meansthatPdecreasessincelesslaborisrequiredforproduction.ThedecreaseinP
increasestherealwage.
0000
5. Asinquestion4,theeconomyisatthemedium-runequilibrium(pointM),butit
experiencesanincreaseinproductivitywhichdoesnotaffectAD.Ifpeoples
expectationsaboutproductivityarealwayscorrect,whathappensintheshort-and
medium-run? Showgraphically.Labelallcurves. Labelshort-andmedium-run
equilibriaclearly.(11points) (hint: u=1Y/AL)
i
M
LM
0
IS
0
M
LM
SR
i
0
LM
MR
M
IS
MR
IS
1
i
YN Y
1
N Y
1
Y
2
N Y
E E
P
M
AS
0
AD
0
M
AS
SR
P
0
AS
MR
M
Y
1
N
Y
1
Y
2
N
Y
Intheshort-run:
Whenproductivityincreases(anincreaseinA),theAScurveshiftsdownandtotheright.
ThislowersPwhichhas2effects.First,therealmoneysupplyincreaseseventhoughthe
nominalmoneysupplyhasnotchanged.ThisshiftstheLMcurvedown.Atthesame
time,adecreaseinPleadstoarealdepreciationofthedomesticcurrency. This
increasesnetexportsduetotheMarshall-Lernercondition.So,theIScurveshiftstothe
rightalso. TheintersectionofIS-LMmustbeatpointM.Why?Afixedexchange
regimemeansthati=i*andE= E. (Note:IfthedecreaseinPisnotenough(ortoo
much)toincreaserealmoneysupplywhichwouldcorrespondtoLM
SR
,thenthecentral
bankmusteitherincrease(ordecrease)nominalmoneysupplysothati=i*is
maintained,sincethatswhatitmeanstobeinafixedexchangeregime.)
AnotherimportantpointhereisthatwithahigherA(productivity),doesnotchangethe
naturalrateofunemploymentsincepeoplesexpecationswerecorrect.However,u=1-
(Y/AL).So,eventhoughu
N
isconstant,Y
N
increases.
Short-runtomedium-run:
AtpointM,theeconomyisperformingatalevelbelowthatofthenaturallevelof
output. So,peoplesexpectationsofpricesstarttodecrease.AsP
e
decreases,theAS
curvestartstoshifttotheright/downuntilitreachespointM.AstheAScurvemoves
towardpointM,theactualpricelevelalsodrops.Thisincreasesrealmoneysupply
(theLMcurveshiftsdown)andtherealexchangerate(ISshiftsright).Again,sincei=i*
atalltimes,weknowthatatpointM,theISandtheLMcurvesmustintersect,andthe
ASandtheADcurvesmustalsointersect.
LongQuestionII(45/100points)
Growth
(
TheRepublicofSolowakiahasthefollowingproductionfunction:
1
Y
t
= K F
t
,N
t
)= K A
t

N
t
,where <1.
t
AssumefornowthatA
t
isconstantovertime(thereisnotechnologicalprogressinthis
economy,soA
t
=A),g
N
isthegrowthrateofN,istherateofdepreciationinthis
economy,andsisthesavingrate.
1. Verifythattheaboveproductionfunctionhasthepropertyofconstantreturnstoscale
andrewritetheproductionfunctionintermsofonlycapitalperworker.(Define
K
t
k
t
=
N
t
andy
t
=
Y
t
.)
N
t
First,wemustverifythatf( K
t
, N
t
)= f(K
t
,N
t
),thatis,ifyoumultiplyallinputsby
ascalar,youwillendupmultiplyingoutputbythesameamount.
( N
t
)
1
=
+ 1
AK
t
1
f( K
t
, N
t
)=A( K
t
)

N
t
= AK
t

N
t
1
= f(K
t
,N
t
).
Towritetheproductionfunctioninintensiveform,let =1/N.

1
A

A
K N K
t t t
K F ) 1 , ( = =
t
N N N
t t t
( ( Definefsothat k f
t
) k F ) 1 , .
t
Then,y
t
=f(k
t
)=Ak
t

.(RecallthatAisjustaconstantinthismodel!)
2. Solveforthesteadystatevaluesofcapitalperworker(k*),outputperworker(y*),
andconsumptionperworker(c*).Drawadiagramthatshowsallthreesteadystate
valuesyoucalculated.
Recallthatthesteadystateisgivenbythecrossingoftheinvestmentandtherequired
investmentschedules.Thatis,sf(k*)=(g
N
+)k*.(Seepage225.)
s
*)( ( * k f ) k =
g
N
+
( *) ( k*= k A

s
)
g
N
+
*) (
1
= A(
s
) k
g
N
+
1 1
1
k*= A
1
(
s
)
g
N
+
Pluggingthisk*intotheproductionfunction,wegety*:
1 1 1
s
1
y*=A(k*)

= A A
1
(
s
)
1
)

= A
1
( ) (
g + g +
N N
c
t
=y
t
(1-s)
1
c*= A
1
(
s
)
1
1 ( s)
g +
N
k g
N
) ( +
sAk

y
k
y*
c*
Ak

RequiredInvestment
Investment
Productionfunction
k*
3. Findthesavingrateatwhichsteady-stateconsumptionismaximized(i.e.weareat
theGoldenRulesteadystate).
Thereareafewwaysofdoingthis,butherewewillmaximizesteady-state
c*
consumptionbysetting equaltozero.
k*
Notethatc*=y*--sy*=y*--(+g
N
)k*
c* y*
= ( + g
N
)
k* k*
y*
= ( + g
N
)
k*
y*
*) (
1
= A k
k*
1 1
A (A
1
(
g
s
+
)
1
)
1
= + g
N
N
(
g +
N
)= + g
N
s
s=.
Thissaysthattheoptimallevelofsavingsisequaltotheshareofcapitalinthe
productionfunction, .Theintuitionisthatdiminishingreturnsreducetheusefulness
ofadditionalunitsofcapital,soinvestingmoreisnotalwaysoptimal.
4. Supposethatattimetthereisaone-timeinflowofforeignworkersintothecountry,so
thatNjumpsfromN
0
toN
1
.(Assumethatthisdoesnotaffectg
N
.)Drawtwodiagrams:
oneshowingwhathappenstotheinvestmentandrequiredinvestmentschedules,
includingdynamics,andonedepictingtheeffectsofthisinflowoncapitalperworker
overtime.
AninflowofforeignworkersisequivalenttoanincreaseinN.Therefore,K/N
decreases(kdecreases).So,inthiscase,capitalperworkerwould(immediately)
jumpdowntoalevelsuchaskintheshort-run.However,inthelongrun,the
dynamicswillbringtheeconomybacktotheoriginalsteady-statelevelofcapitalper
effectiveworker,k
1
*.Why?WhenthereisanincreaseinN,weendupatpointE,
whereinvestmentperworkerequalstheverticaldistanceEk.Theamountof
investmentrequiredtomaintainthatlevelofcapitalperworkerisclearlysmaller
thantheamountEk(distanceDk).Becauseactualinvestmentexceedsinvestment
thatisrequiredtomaintaintheexistinglevelofcapitalperworkeratE,kincreases.
Hence,startingfromk,theeconomymovestotheright,withthelevelofcapitalper
workerincreasingovertime.Thiscontinuesuntilinvestmentperworkerisjust
sufficienttomaintaintheexistinglevelofcapitalperworker,thatisuntilwereturnto
theinitialsteady-state,E.(Seepage248.)So,theeffectofimmigrationwillonlybe
temporary(becausenothinghappenedtoinvestmentorrequiredinvestment).
E

sAk

E
Ek

D
Dk
k g
N
) ( +
RequiredInvestment
y
Investment
k
k k*
k
k
Thefigureontheleftdepictstheevolution
ofcapitalperworkerovertime. Priorto
timet,capitalperworkerisatthelevelk*.
Attimet,whenthereisaninflowof
workersintoSolowakia,capitalper
workerimmediatelydropstok.Then,
overtime,capitalperworkerincreases
backtotheoriginalsteady-statelevel,k*.
t
Time
5. SupposeSolowakia(S)andMacronesia(M)haveidenticalproductionfunctionsand
same ,g
N
,ands.However,A
S
>A
M
. Whichcountrywillhaveahighersteady-state
capitalperworker?Proveyouranswermathematicallyandwithadiagram.
1
1
s
k*= A1 ( )
1
,wherei={S,M}
i
g +
N

s
1
k* 1
1
>0
A
i
=
1
A
i
1 (
g +
)
N
(Because <1andalltheotherparametersarepositive)
Therefore,asAincreases,k*increases.So,thecountrywithahighertechnological
parameter,A,willhaveahighersteady-statelevelofcapitalperworker(which,in
thiscase,isSolowakia).Intuitively,thisfollowsfromthefactthatthistechnological
changeincreasesthemarginalproductofcapitalateverylevelofperworkercapital
stock.
y
k
E
sA
S
k



F
k g
N
) ( +
sA
M
k

k
M
* k
S
*
6. Assumethatallcountriesareheadingtowardsthesamesteadystate(thatis,inthe
longrun,allcountrieshaveaccesstothesametechnologyandhavethesame
preferencesasmanifestedinthesamesavingrateandpopulationgrowthrate).Does
themodelpredictgrowthforpoorercountriesshouldbefaster,slower,orthesameas
richercountries?Showmathematically.(Hint:Definethegrowthrateofcapital
k
t
asg = .)
K
k
t
Inthismodel,apoorcountryispoorbecauseitscapitalperworker(k)isfurther
belowthesteady-statevaluethanisthecapitalperworkerofarichcountry(i.e.the
marginalproductofcapitalisgreaterinthepoorcountry).Thisalsomeansthatits
incomeperworker(y)isfurtherbelowthesteady-stateincomeperworker.
Countriesthatareapproachingthesteadystatefrombelow(whichistrueforpoor
countries)growaccordingtotheexcessofactualinvestmentoverinvestmentthatis
requiredtomaintainexistinglevelofcapital.Thegreaterthedifference,thefasteris
growth. Thatis,countriesthatstartoutwithlowerk(poorcountries)growfaster
thancountrieswithkclosertothesteadystatek(richercountries).
Mathematically:
K
t+ 1

K
t
N
t
N
t
= k
t+ 1
k
t
= k
t
= sy
t
( + g
N
)k
t
(Seepage223,equation11.2.)
Dividingbothsidesbyk
t
:
k
t
y
t
k
t
= g
K
= s ( + g
N
)
k
t
Recallthatinpart1wefoundthaty=f(k)=Ak

.

g = sA
k
k
t
t
( + g
N
)= sAk
t
1
( + g
N
)
K
K 2
< Weseethatsince0< <1,g
K
isdecreasingink(i.e.

g
k
t
= sA( ) 1k
t
0).
7. Supposethat =0.5inthegivenproductionfunction.Assumethatthelevelof
technologyinthecountrydependsoncapitalperworker,inparticularA=k

. Discuss
convergenceandgrowthinaneconomywith =0.5andcompareittoaneconomy
with <0.5. Usediagramsandwords.
Forthiseconomy,y
t
=k
t
+0.5
Convergencethereforewilldependonthevalueof .Iftheinvestmentfunction,that
+0.5
issk

,isconcaveincapitalperworker,thenthereexistsasteadystatetowards
whicheconomieswithsimilarsavingrates,technologygrowthrates,and
depreciationrateswilleventuallyconverge.Ifitisconvex,wewillnotconvergetothe
steadystate(thesteadystatewillbeunstable).
Forwhatvaluesof willthefunctionbeconcave/convex?Wecanlookatthesecond
partialwithrespecttocapitalperworker,aswedidontheproblemset:
y
t
= ( + ) 5 . 0 k
5 . 0
k
t
t
2
t 5 . 1

k
y
t
2
= ( + 5 . 0 )( ) 5 . 0 k
t
Thislastexpressionisnegative(andthusthefunctionisconcave)ifandonlyif
<0.5.For >0.5,itisconvex.When =0.5,thefunctionisaline.
Inparticular,thefollowingdiagramdescribestheeconomywhen =0.5.
y
Investment
Required
Investment
k
k
0
Ifthecountrystartsoutatthelevelofcapitalperworkersuchask0,itwillgrow
forever.Thisistrueforanystartinglevelofcapitalperworker.Inthissense,the
economywillneverconvergetoasteadystate.Thereasonisthattheproduction
functionislinearincapital,andthereforeitdoesnotexhibitdiminishingreturnsto
capital.
Whataboutgrowthinthiseconomy?Wecanusethesamelogicasinpart7to
answerthisquestion.
k
t+ 1
k
t
= k
t
= sy ( + g )k
t N t
k
t
= sAk
t
( + g )k
N t
Dividingbothsidesbyk
t
:
k
t
k
t
= g
K
= sA g ,whichisaconstant.
N
Thisshowsthatkgrowsataconstantrate.So,thisisamodelofendogenousgrowth,
becauseitgeneratessteadygrowthevenwithouttechnologicalprogress.Incontrast
totheSolowmodel,growthdepends,eveninthelongrun,onthesavingrate.
For <0.5,thereexistsasteadystatetowhicheconomieswilleventuallyconverge.
Tofinditweagainsetsf(k*)=(g
N
+ )k*.
k s *)
+ 5 . 0
(
k*=
g
N
+
(k*)
5 . 0
s
=
g
N
+
1
k*= (
s
)
5 . 0
g
N
+
)
s
5 . 0 +
5 . 0
y*= (k*)
+ 5 . 0
= (
g
N
+
Wehavethestandarddiagram.(Seesolutiontopart4.)
Inthismodel,justasinthestandardSolowmodel,thereisconvergencetothesteady-
state.
TherestofthesolutionisjustF.Y.I.
Whataboutwhen >0.5?Thenthediagrambecomes:
y
k

C
k
0 k
0
k**
RequiredInvestment
Investment
ThesteadystateCislocallyunstable.Thatis,ifwestartatanylevelofcapitalper
workerbelowk**,theeconomywillshrinktonothing(illustratedbythemovefromk
0
tozero).So,thisislikeapovertytrapthecountrythatstartsoutverypoornotonly
stayspoor,butgrowspoorerovertime.Why?Becauseatk
0
,theamountofinvestment
requiredtomaintainthatlevelofcapitalperworkerexceedsactualinvestment.
Therefore,kdecreases,andtheeconomymovestotheleft,withthelevelofcapital
perworkerdecreasingovertime.
However,iftheeconomystartsatalevelofcapitalperworkerabovek**,thenthe
economywillgrowforever.Thisisbecauseatk
0
,actualinvestmentexceedsthe
amountofinvestmentrequiredtomaintainthatlevelofcapitalperworker.Therefore,
kincreases,andtheeconomykeepsmovingtotheright,withthelevelofcapitalper
workerincreasingovertime.
Inthissense,thereisnoconvergenceforaneconomywith 5 . 0 .