Solow Growth Model

• There is a huge debate that why some

countries like Switzerland and Norway have
level of GDP which is hundred times higher
than GDP of other poorest countries like
Nigeria and Haiti.
• Key factors here are production all ‘physical
capital’ and the key process is that of
‘convergence’.
• The model and derivation of the most
important equation and its most important
implication is convergence.
 Basic Assumptions
• 1) The aggregate production function have the
following production function F

• where
• = total GDP measured from the production
side
• = total physical capital
• = aggregate labor force
• 2) Constant Return to Scale (CRS)

• 3) All factors of production have positive but

diminishing marginal return.
• , at all levels of k
• , at all levels of L
• The CRS assumption means for instance
doubling the level of K and L , we will get
doubling the level of total output.
• The second assumption implies that F has a
concave relationship with both production
factors and that the MP is always positive.
• 4) Intense functional form:

• The aggregate production function is as

follows ;

• This transformation is referred to as an

intensive form and is referred to as a capital
per worker.
• The incentive form of production function also
have following properties.
• for all levels of
• The most often form of production function used
in economics is cobb Douglas.

• Dividing through by L gives us the incentive form

or per capita form, or output per worker .
•

• k = K/L
 Dynamics
• All variables are the function of time so next
step is to specify their dynamics.
• The growth of labor L is in the model is
exogenously given i.e. not explained by the
model.

• Where >0 implying

• = percentage share of labor force or (of
population size ) and time derivative indicate
the changes in the stocks.
• is growth rate during the year .

• A typical level of n would be 0.01 -0.05

• The key dynamic equation in the Solow growth
model is that specifying the rate of change in
the physical capital stock.
• In this expression is the fraction of Y that is
saved. is the capital depreciation rate.
• Typical and often observed level are and .
• Expression (5) can be restated as
•
• Total saving can be used for net Investment
and depreciation of capital which together is
total investment.
• The Solow model implicitly assumed a closed
economy without trade with no government.
• Then the equation of the economy is
•
• Now express into intensive form
•
•
• =

• Put from equation (5)

•
• OR
• =
•
• The expression in equation 6 is the central
equation of the Solow growth model.
• Equilibrium
• is concave since
• is same times reflected as actual level of
investment.
• is a breakeven investment
• Vertical difference between and gives
consumption per unit of labor
• Below
• At steady state capital and labor grow at a
balance rate.