In the Solow model, you’ve seen that as the total stock of capital equipment gets larger, the number of machines wearing out grows as well. Often, most investment ends up just replacing worn-out machines. This is actually true in the United States and other rich countries. According to the U.S.

National Income and Product Accounts

(the official U.S. GDP measures), about 12% of total GDP just goes toward replacing worn-out machines and computers and construction equipment.

a. In the Solow model, if the depreciation rate increases, what happens to the steadystate capital level and output level? Answer in words and by using a diagram such as Figure 26.4. (Bonus: If the depreciation rate increases from 0.02 to 0.03, what is the new steady-state level of capital and output?)

b. If the Solow model explains an important part of the real world, should countries hope for high depreciation rates or low depreciation rates? How does this square with the observation that when machines wear out, that “creates jobs” in the manufacturing industries? 558