On the diagram above, show the new steady-state capital-labor ratio th

On the diagram above, show the new steady-state capital-labor ratio that results from a decrease in the saving rate. Can you say what has happened to the equilibrium level of consumption per worker?

What will be an ideal response?

ANSWER

As saving/investment falls, the equilibrium capital-labor ratio declines along the depreciation line. As the capital-labor ratio falls, output-per-worker declines along the production function. Beginning from the original equilibrium k* on the graph, the production function is clearly flatter than the depreciation line, so the decline in output is smaller than the decline in saving/investment, so that consumption per worker must be rising. Consumption per worker can fall only if k* is so low that the slope of the production function (at that level of capital per worker) is steeper than the depreciation line.