Term 2, AY 2021-2022

Solow Growth Model Wrap-Up

Marie Aragones, MSc in Economics

 2

Agenda • Capital Accumulation, Steady-State Review

• Cobbs-Douglas Production Function
• Steady-States with varying savings rates
Steady-State Review
Based on your understanding,
explain the dynamics of capital
accumulation
Based on your
understanding,
explain the dynamics 𝒌𝒕"𝟏 − 𝒌𝒕 = 𝒔𝒇 𝒌𝒕 − 𝜹𝒌𝒕
of capital • Change in capital from one period to another is

accumulation
called capital accumulation
• Investments are additions to capital
• Depreciation is the breakdown of capital over
time
• Capital stock in the next period is determined
by undepreciated capital from the current
period and investments
What is the steady-state level
of capital [per worker] and
output [per worker]?
What is the steady- • Steady-state is the level of capital
state level of capital [per worker] and output [per
worker] the economy converges to
[per worker] and in the long-run
output [per worker]? • At the steady-state, capital per
worker and output per worker does
not change
Why does the steady-state exist?
 • Investment per worker is subject to
diminishing returns
• Depreciation occurs at a constant
rate
Why does the steady- • Eventually, depreciation will
state exist? outpace investment
• Steady-state is the level of capital
per worker and output per worker
where investment is exactly
sufficient to replenish depreciated
capital
What role does the
savings rate play in long-
run economic growth?
What role does the
savings rate play in • Savings increases the level of
capital per worker and output
long-run economic per worker in the long-run
growth?
Cobbs-Douglas Production
Functions
 13

𝒀 = 𝑭(𝑲, 𝑵)
The production function
given so far has been a
general representation
 14

𝜶 𝟏#𝜶
𝒀=𝑲 𝑵
In macroeconomics, there are
several functional forms, one of
which is the Cobbs-Douglas
function – a nonlinear
representation of the relation
between output, and the inputs
to production
 15

𝜶
𝒀 𝑲 𝜶
= ⇒𝒚=𝒌
𝑵 𝑵
The intensive form of
the production function
may be written as
follows
 16

𝒅𝒚 𝜶"𝟏
= 𝜶𝒌 >𝟎
𝒅𝒌
Firms produce more output
per worker given more
capital per worker
 17

𝟐
𝒅 𝒚 𝜶"𝟐
𝟐
= 𝜶 𝜶 − 𝟏 𝒌 < 𝟎
𝒅𝒌
Each additional unit of capital
per worker increases output
by less and less. This shows
diminishing returns to capital
per worker
 18

𝜶
𝒊 = 𝒔𝒚 = 𝒔𝒌
Investment per worker
is given as follows
 19

𝒌𝒕"𝟏 − 𝒌𝒕 = 𝒔𝒌 𝜶 − 𝜹𝒌𝒕
𝒕
The capital accumulation
function is given as follows
 20

𝟏
∗
𝒔 𝟏&𝜶
𝒌 =
𝜹
The steady-state level of
capital per worker is given
as follows
 21

𝜶
∗
𝒔 𝟏&𝜶
𝒚 =
𝜹
The steady-state level of
output per worker is given
as follows
Steady-States with varying
savings rates
 23

𝟎.𝟓 𝟎.𝟓
𝒀=𝑲 𝑵
Given this aggregate production
function, we can derive and
characterize the intensive form
production function, and obtain
the steady-state level of output
per worker and capital per worker
 24

𝟎.𝟓 𝟎.𝟓
𝒀 𝑲 𝑵 𝟎.𝟓
= ⇒𝒚=𝒌
𝑵 𝑵
The intensive form of
the production function
may be written as
follows
 25

𝒅𝒚 "𝟎.𝟓
𝟎. 𝟓
= 𝟎. 𝟓𝒌 = 𝟎.𝟓 > 𝟎
𝒅𝒌 𝒌
Firms produce more output
per worker given more
capital per worker
 26

𝒅𝟐 𝒚 𝟎.𝟓%𝟐
𝟎. 𝟐𝟓
𝟐
= 𝟎. 𝟓 −𝟎. 𝟓 𝒌 = − 𝟏.𝟓 < 𝟎
𝒅𝒌 𝒌

Each additional unit of capital

per worker increases output
by less and less. This shows
diminishing returns to capital
per worker
 27

𝟎.𝟓
𝒊 = 𝒔𝒚 = 𝒔𝒌
Investment per worker is given as
follows – note that investment per
worker can be expressed in terms
of capital per worker
 28

𝟎.𝟓
𝒌𝒕"𝟏 − 𝒌𝒕 = 𝒔𝒌𝒕 − 𝜹𝒌𝒕
The capital accumulation
function is given as follows
 29

𝒔 𝟐
∗
𝒌 =
𝜹
The steady-state level of
capital per worker is given
as follows
 30

∗
𝒔
𝒚 =
𝜹
The steady-state level of
output per worker is given
as follows
 31

𝜹 = 𝟏%
𝒔𝟏 = 𝟐𝟓% ; 𝒔𝟐 = 𝟒𝟎%
Assume a depreciation rate of 5%. Compare the
steady-state level of capital per worker and output
per worker at a savings rate of 5% and 10%
 𝟐
32

∗ 𝟐𝟓%
𝒌𝟏 = = 𝟔𝟐𝟓
𝟏%

∗ 𝟐𝟓%
𝒚𝟏 = = 𝟐𝟓
𝟓%
The steady-state level of capital
per worker for 𝒔𝟏 is given as
follows
 𝟐
33

∗ 𝟒𝟎%
𝒌𝟏 = = 𝟏𝟔𝟎𝟎
𝟏%

∗ 𝟒𝟎%
𝒚𝟏 = = 𝟒𝟎
𝟓%
The steady-state level of capital
per worker for 𝒔𝟐 is given as
follows
Physical Versus
Human Capital
 35

• Relaxes the assumption of the homogeneity of

Human Capital inputs for workers
• Human Capital refers to the health and
Accumulation educational outcomes within a population
• Healthy and skilled workers tend to lead to better
outcomes for an economy
• While holding the quantity of workers constant, the
production function can be further extended to
account for the human capital accumulation
• Much like physical capital accumulation, human
capital accumulation necessitates investment,
and is subject to depreciation
 36

• The measurement of human capital is much

Human Capital more complex than the measurement of
physical capital
Accumulation
• The value of investment in human capital
does not only comprise explicit costs but
also implicit costs, and noneconomic –
sometimes non-quantifiable – costs
• The returns to human capital is similarly not
as straightforward to gauge compared to
physical capital