Roll no.: 21870002 Course: B.A Economics (H) Teacher Incharge: Mr. Umer Robert Merton Solow is an American Economist, who received Nobel price in economic sciences in 1987. Particularly known for his work on the theory of economic growth that culminated in the exogenous growth model named after him. Solow model of economic growth Prof. R. M. Solow builds his model of economic growth as an alternative to the Harrod-Domar model. As Harrod Domar model was based on a crucial assumption of fixed proportions in production. But Solow postulated a continuous production function linking output to input of labour and capital which are substitutable. Solows growth model is an exogenous growth model. Assumptions 1) Prices , wages and investment rates are flexible. 2) Labour and capital are substitutable to each other. 3) Production function is homogenous and of first degree which means there is a constant returns to scale of production Y= AK α L 1 − α where 0< α< 1. 4) Labour and capital are paid according to their marginal physical productivity and marginal productivity of labour and capital decreases with increase in labour and capital. 5) Labour force is exogenously determined and increase with n rate. 6) Saving is constant proportion of income (S= sy) and saving is equal to investment. Explanation The model assumes that initially, the economy is in a position of minimal capital stock. Hence, in every specified period, the capital stock will increase with the help of saving until it reaches a steady state where the depreciation equals the savings. During the path to a steady state of capital stock, there will also be an increase in consumption per capita, leading to the economy’s growth. Furthermore, as soon as it achieves the steady-state, the consumption per capita also becomes saturated. As a result, economic growth stops. Therefore, if the economy has to witness any more growth, then the exogenous factors have to change, like the improvement in the technology for enhancing the quantity of output vis-a-vis the inputs for production. Steady state Steady state shows long run equilibrium of economy. It shows that regardless of the level of capital with which economy begins it will end at steady state level of output. So, for steady state equilibrium capital must be increasing equal to (n+d)k. So,at steady state capital and investment must be growing at same rate as labour force. So above equation shows the condition for steady state growth rate when capital per worker and therefore income per capita remain constant . In solow’s model we use per worker production function as; Y=AF(K, L) Where Y is income or output K is capital L Is labour. tY=AF(tK, tL) Y/L=AF(K/L, 1) _______t =1/L
Where y= Y/L is output per worker, k= K/L is capital labour ratio.
Thus, the production function can be written as y =AF(k) GRAPHICAL EXPLINATION
Output per worker y is measured on y axis &
capital per worker k is measured on x –axis. The y =f(k) curve is the production function. The S=sy curve represents saving per worker. The (n+d) k is the investment requirement line. The steady state level of capital is determined where the S=sy curve intersects the (n+d) k line at a point E. The steady state income is y with output per worker P, as measured by the point p on the production function In order to understand why k is a steady state situation, suppose the economy starts at the capital labour ratio k1. Here saving per worker k1B exceeds the investment required to keep capital labour ratio constant. K1A, (K1B>K1A.) Thus, k &y increase until k is reached where the economy is in the steady state at point E. Alternatively , if the capital labour ratio is k2 , the saving per worker K2C will be less than investment required to keep capital labour ratios constant K2D, (K2C < K2D) . Thus, y will fall as K falls to K & economy reaches the steady state E.
The solow model shows that the growth process is stable. No matter where the economy starts, forces exists that will push the economy over time to steady state. Thank you