Professor Ruxandra Boul

The Solow Growth Model

The Solow growth model is one of the most important models used by macroeconomists in the world
today because it provides us with significant insight into the capital accumulation process. Building on
the basic production model, the Solow growth model endogenizes the accumulation of capital stock and
helps explain why countries with high investment rates have high capital-output ratios. Through the
principle of transition dynamics, it also provides an explanation for differences in growth rates across
countries; namely, that countries further away from the steady-state level of capital stock and
production have faster growth rates. However, even with these contributions, the limits placed on the
model by its reliance on the process of capital accumulation leave the Solow growth model unable to
explain a significant portion of the short-term growth experienced by countries in transition and unable
to explain the long-term growth experienced by the majority of countries having reached steady states.

In this handout we look at the adjustment process, or the transition dynamics, surrounding a return or
movement to a steady-state solution for a country.

1. Consider the economy represented by the accompanying Solow Growth Model:

a. The first step is to combine the investment allocation equation with the capital
accumulation equation.

1
 Δ ft 54 Ike

b. Using the fixed amount of labor in an economy, write down the production function.

Lt AK L

c. Begin by drawing the steady-state solution for the country described by this model on a
Solow Diagram. What are the steady-state values for capital, output, investment and
consumption? Label these on your diagram.

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leprae
ye

in

I
S 24C
capitulth

state
study 2
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d. Using the Solow diagram, at what point do the two curves intersect? Solve for the
steady-state level of capital stock using the capital accumulation equation in the steady-
state.

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sy
55K IKE
r 5
1ˢ
e. Solve for the steady-state level of Output.

y A
I F I t

A
E I
f.
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Solve for the steady-state level of output per person.

y E A

3
 g. Use the accounting exercise (from the Cobb-Douglas production model) with the steady-
state equation for output per person. Assume the depreciation rate is the same in rich
and poor countries.

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l w̅ ke 5A K2

line
study state
ta At
IT kt
kt

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L means capitalwater