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Lecture 3-AE-Solow Growth Model

The Solow growth model explains long-run economic growth through capital accumulation, population growth, and technological progress. It shows that economies converge to a steady state of constant per capita output and capital unless disturbed by changes to savings rates, population growth, or technology. An increase in the savings rate, for example, leads to higher capital intensity and output per worker by raising investment and shifting the steady state to a new, higher level.

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Akshav El Nino
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© Attribution Non-Commercial (BY-NC)
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120 views

Lecture 3-AE-Solow Growth Model

The Solow growth model explains long-run economic growth through capital accumulation, population growth, and technological progress. It shows that economies converge to a steady state of constant per capita output and capital unless disturbed by changes to savings rates, population growth, or technology. An increase in the savings rate, for example, leads to higher capital intensity and output per worker by raising investment and shifting the steady state to a new, higher level.

Uploaded by

Akshav El Nino
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as PDF, TXT or read online on Scribd
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1

Growth Models
Lecture 3
SolowGrowth Model
2
Over decades and centuries more and more goods are
produced and standards of living continually
improve.
Economic growth has been responsible for staggering
changes in the way we live.
4 reasons why economies grow
Investment adds to capital stock
Population grows
Technological progress
Advances in productivity
3
Properties of the
Cobb-Douglas Production Function
4
Production function (intensive form) gives
gross output per worker
Output-labour
ratio
(y=Y/L)
0
y=f k ( )
Capital-labour ratio
(k=K/L)
5
1
k
=s f k saving ( )
1
Saving per worker depends on y (output per
worker) that depends upon k (capital per worker)
Output-labour
ratio
(y=Y/L)
0
y=f k ( )
1
( ) f k
2
( ) f k
2
k
2
3
( ) f k
3
k
( )
1
s f k
( )
2
s f k
( )
3
s f k
3
Capital-labour ratio
(k=K/L)
6
Depreciation
The proportion of capital is lost due to
depreciation.
The change in capital stock is:
K=sY-K
In intensive form:
k=sy-k
Depreciation is represented by the
depreciation line.
7
Constant fraction () of capital per worker is used
up (decays, melts) in production each period
Output-labour
ratio
(y=Y/L)
0
y=f k ( )
= k depreciation
Net output
( ) =f k k
k =replacement investment needed
to maintain constant capital intensity
Gross output
( ) =f k
kk
Capital-labour ratio
(k=K/L)
8
When k adjusts
If investment exceeds depreciation, the capital stock
rises.
sy>k (capital intensity rises)
The capital stock could shrink if investment is smaller
than depreciation.
sy<k (capital intensity falls)
9
At k
1
,

k <s

f(k) and k will rise.


Output-labour
ratio
(y=Y/L)
0
y=f k
Production function
( )
=s f k saving ( )
= k depreciation
B
A
k
1
0 k A > {
C
D
k
Capital-labour ratio
(k=K/L)
10
} 0 k A <
At k
2
,

k >s

f(k) and k will fall.


Output-labour
ratio
(y=Y/L)
0
y=f k
Production function
( )
=s f k saving ( )
= k depreciation
k
2
A
B
k
Capital-labour ratio
(k=K/L)
11
Review: The steady state
Output-labour
ratio
(y=Y/L)
0
y=f k
Production function
( )
=s f k saving ( )
= k depreciation
B
A
D
C
k
1
0 k A > {
} 0 k A <
k
2
k
Capital-labour ratio
(k=K/L)
12
The Steady State
The steady state equilibrium for the
economy is the combination of per capita
GDP and per capita capital where the
economy will remain at rest; that is; where
per capita economic variables are no
longer changing.
y=0, k=0
13
Exercise
Using the SolowGrowth model, illustrate
the effect of an increase in saving rate on
the capital-labour ratio.
14
An increase in the saving rate leads to
greater capital intensity and output per worker
0
=s f k old saving ( )
= k depreciation
Output-labour
ratio
(y=Y/L)
' =s f k new saving ( )
Capital-labour ratio
(k=K/L)
15
The more a country saves the more it invests,
the more it invests, the higher is its capital-
output ratio.
In the long-run, countries with high savings and
investment rates have high per capita incomes.
Poor countries in Africa typically invest little in
contrast with the richer countries of Europe and
Asia.
16
However
When decreasing marginal productivity starts to set in, capital
accumulation cannot sustain permanent growth.
How to account for increasing standards of living? One solution:
Population growth.
Labour input grows either when more people are at work or each
worker works more.
The increase inlabour input is a source of growth.
For capital-labour ratio to remain unchanged in the steady state,
investment must not only compensate for capital depreciation but
also for labour force growth.
How to account for population growth in the Solowmodel?
17
Steady state condition with population growth
18
Steady state with population growth (n
1
>0)
Output-labour
ratio
(y=Y/L)
0
=s f k saving ( )
1
) n + capital widening ( k
1
k
A
1
Capital-labour ratio
(k=K/L)
19
Exercise
Population growth rate rises from n
1
to n
2
.
What will be the effect of this on the
steady state?
20
Rate of population growth rises from n
1
to n
2
...
Output-labour
ratio
(y=Y/L)
0
=s f k saving ( )
1
k
1
) n + capital widening ( k
A
1
2
) n + ( k
... and steady state capital intensity will fall
2
k
A
2
Capital-labour ratio
(k=K/L)
21
The steady state with population growth and
technological progress
22
Steady state implies a state of rest, that is
the capital-labour and output-labour ratios
are constant.
This implies that the standards of living are
not rising.
However economies keep growing, why?
Technological Progress
23
Steady state with population growth
and technological progress
24
Steady state with population growth
and technological progress
Output-
effective
labour
ratio
(y=Y/AL)
0
Capital-effective labour ratio
(k=K/AL)
=s f k saving ( )
) a n + + k capital widening (
A
k
25
An improvement in technology
26
In the Solow model the uniqueness of the steady
state level of capital per effective worker and output
per effective worker is due to the assumption of
diminishing marginal productivity of capital (i.e. that
the production function is curved).
Recall the so-called capital widening line is a straight
line: (a +n +)k
Endogenous growth
27
Unique steady state if production function is
curved
Output-
effective
labour
ratio
(y=Y/AL)
0
=s f k saving ( )
) a n + + k capital widening (
A
k
Capital-effective labour ratio
(k=K/AL)
28
Technological progress offsetting
diminishing marginal productivity
Technological improvement in capital happens to be just
fast enough to offset the diminishing marginal
productivity of capital.
29
}
0 k A >
Endogenous growth
Output-
effective
labour
ratio
(y=Y/AL)
0
) a n + + k
capital accumulation
(
( y=f k
production function
)
( =s f k saving )
k
1
B
A
D
C
k
2
0 k A > {
Capital-effective labour ratio
(k=K/AL)
30
Notice what happens if the saving rate increases
Output-
effective
labour
ratio
(y=Y/AL)
0
) a n + + k
capital accumulation
(
( y=f k
production function
)
( =s f k saving )
( ' new saving ) =s f k
Capital-effective labour ratio
(k=K/AL)
31
}
{
Raising saving rate increases growth increments
Output-
effective
labour
ratio
(y=Y/AL)
0
) a n + + k
capital accumulation
(
( y=f k
production function
)
( =s f k saving )
k
1
B
A
D
C
k
2
( ' new saving ) =s f k
}
{
Capital-effective labour ratio
(k=K/AL)

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