Graphically illustrate and explain the effects of an increase in the rate of depreciation (δ) on the Solow growth model. In your graph, clearly label all curves and equilibria.

What will be an ideal response?

ANSWER:

The depreciation line becomes steeper and at the initial K/N depreciation is now greater than investment. In this case, K/N and Y/N will fall. If depreciation is greater than saving, it is also greater than investment. Alternatively, there is insufficient investment to offset the amount of capital that wears out. So, the capital stock will decrease. This will cause a reduction in K/N, Y/N, and S/N. As Y/N falls, so will C/N.