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Solow Model

LPR Chapter 4

**The Basic Growth Model
**

Aggregate Production function

Is based on five equations

1. Aggregate production function Y=f (K,L)

2. Saving(S)= sY

3. S= I (Saving=Investment)

4. ΔK=(I- dK) where d=depreciation and K=

capital

5. Δ L= nxL n=population growth and L=Labor

force,

Combining 2,3,4, leads to ΔK =sY-dK

2

L) Labor and capital are substitutable The production function or Isoquant is ushaped showing substitution as in figure 4. capital and labor Y= f(K.The Solow Model The Solow model is an improvement over Harrod-Domar Model It allows for substitution between factors of production.2 3 .

K-intensive L-intensive 4 4 .

3) 5 .1) y=f(k) We have diminishing returns to capital as in (4.Basic Equations: Divide Y=f (K.L) by L to express all variables in per-worker terms Y/L=F(K/L.

6 6 .

and –dk. -nk.Since ΔK =sY-dK and k = : Δk=sy-(n+d)k Δk is determined by: s. while L growth and depreciation reduces K-per-worker When sy>(n+d)k then Δk is increasing 7 . Thus: S (and I) adds to K-per-worker. where nk is the reduction in capital per worker due to an increase in population.

so k grows if k=݇ଶ and y=ݕଶ : sy<(n+d)k. so k falls all move towards A! 8 .at the intersection: point A: k=݇ and y=f(k)=ݕ at A (steady state): sy=(n+d)k if k=݇ଵ and y=ݕଵ : sy>(n+d)k.

the amount of K needed b/c of n and d just to keep k constant sy>(n+d)k production function saving function sy<(n+d)k 9 9 .

The Solow Growth Model (see 4.4) Point A is where new savings sy = amount of new capital needed for growth in the labor force and depreciation (n+d). 10 . Point A is steady state level of capital per worker where stable equilibrium occurs At steady state total output continues to grow at the rate of population (n) or labor force. but GDP per capita (y) is constant. The savings need to be sufficient to replace depreciated capital and provide new workers with a sufficient amount of capital to maintain the level of capital per worker (k).

k increases from ݇ଵ to ݇ଶ or A to B An increase in the n to n‘ will drop k from ݇ to ݇ଵ or A to C 11 .The Effect of Changes in Saving Rate and Population Growth in the Solow Model An increase in the S in the Solow Model from s to s’.

12 12 .

13 13 .

. high level of output but will not experience high growth rates forever.Saving Rates in the Solow Model • Higher s implies higher saving rates and a higher level of steady-state output. The economy will grow till it reaches its steadystate level of output. • An economy with a high saving rate will maintain a large capital stock. • Higher s means that the economy will have higher economic growth rates in the short run.

. n.Population Growth in Solow Model • Higher the population growth rate. lower the steady state level of capital per worker in the economy and in turn lower the steady state level of output. which implies a lower capital per worker and income per worker at the steady-state level. • An increase in population growth rates will lead to a steeper slope of the (n+d)k line.

s=0. n=0. output has to grow at n in order for output per worker to remain constant.17 Output per worker is 1.07(1.Calculate the Steady-State Equilibrium • • • • • • k=1.05. y=? sy=(n+d)k 0. Higher n results in lower capital per worker and lower output per worker. .1y=0.17.1.67) y=1. d=0.02.67. • At steady-state level.

and assumes saving rate. It does not explain how these parameters change over time 17 . population growth . and technical change as given.Evaluating the Solow Model: Strengths and Weaknesses It is an improvement over H-D Fixed coefficient model With neoclassical production function it allows for substitution between inputs Provides good insights about the relationship between role of technology and innovation on growth Limitations: How can factors that drive steady state influence output.

Beyond the Solow Model: New Approaches to Growth The Solow model assumes fixed or exogenous saving rate. growth rate of savings and labor force. These new models allow for increasing returns to scale and positive and negative externalities They are called endogenous models but their estimation suffers from lack of good data. 18 . Recent works provides models where these variables are determined within or endogenously in the model.

Todaro and Smith Appendix 3.2 The Solow Neoclassical Growth Model Y L = f (K L .1) or y = f (k ) .

2 The Solow Neoclassical Growth Model .Appendix 3.

Appendix 3.2 The Solow Neoclassical Growth Model .

1 Equilibrium in the Solow Growth Model .Figure A3.2.

2 The Long-Run Effect of Changing the Saving Rate in the Solow Model .2.Figure A3.

Factor Accumulation Accounts for Only a Fraction of Growth 3-24 .

com .The Korean Peninsula Source: www.sciencephoto.

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