In The End of Poverty, economist Jeff Sachs recommends a large expansion in foreign

aid from the developed countries to the developing world. This question asks you to

study the impact of foreign aid within the (somewhat narrow) confines of the Solow

model. Please keep in mind when answering what might happen in the short-run and

in the long-run.

Suppose the gift of foreign aid comes in the form of income. Assume the developing

country starts in steady state with a per capita income of $300, and the foreign aid

amounts to $300 per person - provided as a one-time gift. Assume that the developing

country treats this foreign aid just like it treats other income, saving and investing a

fraction s and consuming fraction 1 s . To keep things simple, assume s = 0.10. Also,

to keep it simple, assume there is no population growth.

(a) What are the levels of per capita income and consumption in the year

when the foreign aid is received?

(b) Use a Solow diagram to show how the economy evolves over time in response to this one-time foreign aid. (Note: You do not need to show the immediate impact that you described in part (a) in the diagram.) What happens to income and consumption over time in the short-run and long-run?

(c) Qualitatively, how would your answer to question (b) change if the for-

eign aid were given in the form of capital - electric power plants, plows, trucks, and so on - instead of as income?

(d) How would your answers to questions (b) and (c) change if the country

started with capital per person substantially below the steady state?

(e) Discuss briefly the ways in which foreign aid is and is not useful according to a Solow framework.

(f ) Discuss briefly what is missing in this framework and suggest how this

might affect your view of foreign aid.