Consider two countries ‘Milkie’ and ‘Cookie’. The two countries have identical per capita production function, y = Ak0.5, with initially the same level of technology, A = 1. Also, assume that the saving rate is s = 0.2 for ‘Milkie’ and s = 0.3 for ‘Cookie’, respectively, while the two countries have identical population growth and depreciation rates both equal to 0.1.
(a) Which country has a higher steady state income per capita? Determine the steady state income per capita for each country. Which country has a higher steady state growth rate in per capita income? Why?
(b) Assume now that ‘Milkie’ experiences a productivity boom facing a higher value for A, A = 2 now for this country. All else remaining the same, how would it affect the steady state income for ‘Milkie’? Determine the new steady state income per capita for ‘Milkie’.