The Solow Model Unleashed:

Understanding Economic Growth

Why are some
countries poor?
Why are some
countries rich?
Think about…

Losers of the WW2

Source: https://www.visualcapitalist.com/
Solow Model
 idea capital stock

Y = A eL K
output
people
education

K eL A Output
Output, Y
5 Marginal Product
of Capital
4

MPK
3
Output increase per increase in
y = f(k) capital.
2

0 1 2 3 4 5 6

Capital, K
Output, Y
5 Law of Diminishing Return

4 Decrease in the rate of return

as Capital increases
3

0 1 2 3 4 5 6

Capital Stock, K
Output per Worker, y
5 y = f(k)
*converted to per worker

Growth is a relationship between

3
capital stock per worker and output
y = f(k) per worker
2

consumption
1 y = s f(k)

investment
0

0 1 2 3 4 5 6

Capital Stock per Worker, k

Would Capital continue producing
the same output?
Depreciation per Worker, 𝛿k
5 Depreciation Effect

4
depreciation
Constant part of capital stock
𝛿k wears out every year.
3

2 As Capital increases,
depreciation also increases.

0 1 2 3 4 5 6

Capital Stock per Worker, k

Steady State
Investment & depreciation
5
Steady State
Investment equals depreciation.
4
depreciation
Before k*, investment is more than
depreciation, capital stock grows.
3
After k*, investment is lower than
y = s f(k) depreciation, capital stock
2 shrinks.

1 If savings is increased…
1. Investment raises
0
2. New steady state

0 1 2 3 4 5 6
k* k2 Capital Stock per Worker, k
Steady State
Output per Worker, y
5 Golden Rule
In Steady State, where Consumption
4 is maximized.
𝛿k

3
y = f(k) The right savings rate
2
consumption
leads to Golden Rule.

1 investment y = s f(k)

0 1 2 3 4 5 6

Steady state capital per worker, k*

Is savings good enough?
How does POPULATION
affect the economy?
 Try checking online…
https://demonstrations.wolfram.com/SolowGrowthModel/
Output per Capital (Investment, Depreciation)
8000000

7000000

6000000

5000000

4000000 Investment
Depreciation
Production
3000000

2000000

1000000

0
Investment & Break-even Investment
4000000

3500000

3000000

2500000

2000000 Investment
Breakeven Investment

1500000

1000000

500000

0
Output per Capital (Investment, Depreciation)
8000000

7000000

6000000

5000000

Investment
4000000 Depreciation
Production

3000000

2000000

1000000

0
Investment & Break-even Investment
400000

350000

300000

250000

Investment
200000
Breakeven Investment

150000

100000

50000

0
Investment Break-even Investment
Output per Capital (Investment, Depreciation)
8000000

7000000

6000000

5000000

Investment
4000000 Depreciation
Production

3000000

2000000

1000000

0
Investment & Break-even Investment
4000000

3500000

3000000

2500000

Investment
2000000
Breakeven Investment

1500000

1000000

500000

0
Investment Break-even Investment
What about the future?
Output per Capital (Investment, Depreciation)
8,000,000.00

7,000,000.00

6,000,000.00

5,000,000.00

Investment
4,000,000.00 Depreciation
Productivity
3,000,000.00

2,000,000.00

1,000,000.00

-
Investment & Break-even Investment
4000000

3500000

3000000

2500000

Investment
2000000
Breakeven Investment

1500000

1000000

500000

0
Output per Capital (Investment, Depreciation)
8,000,000.00

7,000,000.00

6,000,000.00

5,000,000.00

Investment
4,000,000.00 Depreciation
Production

3,000,000.00

2,000,000.00

1,000,000.00

-
Investment & Break-even Investment
4000000

3500000

3000000

2500000

Investment
2000000
Breakeven Investment

1500000

1000000

500000

0
Output per Capital (Investment, Depreciation)
8000000

7000000

6000000

5000000

Investment
4000000 Depreciation
Production

3000000

2000000

1000000

0
Investment & Break-even Investment
8000000

7000000

6000000

5000000

Investment
4000000
Breakeven Investment

3000000

2000000

1000000

0
What is next for ?
 Summary

Economic growth was there.

It did not sustain.

 Recommendations

Economic growth is going up.

Investment is going up.

Output per person is growing.

Population growth is going down.

Is Solow Model enough?
Limitations
Limited resources are not
considered.

No quality on labor

Steady state is unlikely due to many

factors. (ex. policies, culture)

Assumptions on constant variables

(ex. population growth, etc.)
 Any questions?
Send your questions, comments, and other concerns to:

Strange Solutions
LT 7 Section A

Arvin Julia Gautham Tonie Wilb

operations branding technology logistics finance
amagpantay@aim.edu jpasumbal@aim.edu gshrinivas@aim.edu tflores@aim.edu wyu@aim.edu