In the Solow growth model, how does an increase in the saving rate affect the steady-state and long-run growth?

• A. It raises the steady-state capital per worker but does not change long-run growth.
• B. It increases long-run growth rate and lowers steady-state capital.
• C. It lowers steady-state capital per worker and increases inflation.
• D. It has no effect on steady-state or growth.

Answer: (A)

Saving behavior drives capital accumulation in the Solow model. A higher saving rate means a larger share of output is invested in capital, so the economy builds up more capital until investment just offsets depreciation. This pushes the steady-state level of capital per worker higher, and with higher capital stock, output per worker is also higher in the steady state.

However, in this framework the long-run growth rate of output per worker is determined by technology, which is taken as exogenous and fixed. Once the economy reaches the steady state, per-capita growth stops, so changing the saving rate does not alter the long-run growth rate. In other words, saving raises the steady-state level of capital and income per worker, but not the long-run rate at which per-capita output grows.