The Solow Growth Model

Assumptions:

1. The economy’s output follows a production function of constant returns to scale (CRS)
2. The two inputs are capital and labor. The production function exhibits diminishing
returns to capital.
3. The economy is closed and there is no government.
4. Savings are a constant rate of the output. The saving rate is exogenous.
5. Population growth at a constant and exogenous growth rate.
6. Capital depreciates at a constant rate.

Annotations:

Y: output y: output per unit of labor =Y/L

K: capital k: capital per unit of labor=K/L (a.k.a capital deepening)

L: labor n: population growth rate
 : Depreciation rate of capital F(K,L): production function with capital and labor as inputs
s: saving rate

Model Derivation

From the CRS assumption:

Y  F K , L
where  is an arbitrary constant. If we assume  is equal to 1/L, then we have:

Y K L
 F , 
L  L L

The above can be re-written as:

y  F k ,1  f k 

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We can assume an explicit form of the production function such as the Cobb-Douglas production
function where:

Y  K  L
The Cobb-Douglas function is mathematical presentation of a production function where  is
the capital elasticity of output and  is the labor elasticity of output. If     1 , then the production
function exhibits constant returns to scale. The above function can, therefore be re-written as:

Y  K  L1
From the CRS assumption we can derive the expression for the output per unit of labor:

  1/ L
Y  (K ) (L)1
Y K L
 ( ) ( )1
L L L
y  k

Capital per unit of labor accumulates according to the following expression:

k  sf k     nk
Capital growth, k , depends on savings, sf k  , net of the amount of capital required to compensate for
depreciation, k , and of the amount of capital needed to maintain the same level of capital per worker to
the new workers, nk .

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Steady State:

A steady state, capital stock per unit of labor is constant:

k  0
sf k     n k

For the Cobb Douglas production function:

k  sk     n k  0
sk     n k
1
 s  1
k*   
  n

Where k * is the steady state level of capital per unit of labor.

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Graphical Representation of the Solow Model

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