A.

The Solow Growth Model (Neoclassical Growth Model)

Solow model of Economic Growth represented an important step forward from the H-
D framework. Solow drop the assumption of H-D model fixed coefficient production
and replace it with a neoclassical production function that allows for more
flexibility and substitution.

In effect, in the Solow model, the capital-output and capital-labor ratios no longer are
fixed but vary depending on the relative endowments of capital and labor in the
economy and the production process.

Neoclassical production function is depicted it in (figure 4) as follows.

Quantity of K
($ million)
Production function

24 d
20 b
c
17 Isoquant II
a = 200,000 tons
10
Isoquant I
= 100,000 tons
100 200 Quantity of L (person -year)

The Basic Equation of The Solow Model

Y =F(K,L),

The key variable of Solow model is per worker terms, and then we express the
production function as follows:
Y (K , L) K
=F =F ( , 1)
L L L ………………………… (11)

where: Y/L = y = output per worker

K/L = k = capital per worker; Then,

The first equation of Solow model is capital per worker as fundamental to the growth
process.

y =f(k) …………………………………. (12)

1
 k

Solow’s model a production function is diminishing return to capital, with fixed

labor supply giving workers with initial amount of machinery to work with will result
in large gain in output. But with the same workers are given more and more
machinery, the addition to output from each new machine gets smaller and smaller.
Figure (5) describes the neoclassical production function, in the Solow model display
diminishing return to capital.

y = f(k)

0 k

The second equation of Solow Model is focus on the determinant change in capital
per worker. This is can be derived from equation (5), then,

∆k = sy – nk – dk, or
∆k = sy – (n+d)k ………………………………… (13)

The equation (13) shows that changes in capital per worker will depend on saving,
population growth rate and depreciation.

Where:
 ∆k is positively related to saving (or investment) per worker. Since s is
the saving rate and y is the output/income per worker, then sy = s. As
saving per worker increase, so does investment per worker, and capital
stock per worker (k) grows.

 ∆k is negative related to population growth, shown by –nk. There are

nL new worker each year, because population growth and labor force.
If there were no new investment, the increase in labor would mean that
capital per worker (k) would decrease by nk.

2
  Depreciation reduces capital per worker by dk.

Terms:
Capital deepening = an increase the amount of capital per worker, k, in the
economy process.

Capital widening = an increase in the capital stock that just keeps pace with
the expending labor force and depreciation.

The Solow Diagram

The diagram of Solow model consists of three curves. 1). Production function curve,
y =f(k); 2). Saving per capita curve, sy, and; 3). Line curve of (n+d)k that represents
the amount of new capital needed as a result of growth in the labor force and
depreciation. The basic Solow growth model diagram depicts it at figure (6) as
follows:
y
(n+d)k
y=f(k)
y2

y0
sy
y1
A

0
k1 k0 k2 k

At point A, amount of capital per worker, k, remains constant, so does the saving per
capital, and also output per worker constant, y=y0 , this situation is called steady state
of the Solow model.

Change in the Saving Rate and Population Growth in the

Solow Model
Change in the saving rate:

3
Increasing in saving from s to s’ shift the saving function from sy to s’y without
widening line (n+d)k. The increase in the saving rate means the saving per worker
now is greater then (n+d)k. Figure (7) shows this changes, k is gradually increase,
from k0 to k1 as result of change in s to s’. At steady sate, the economy shift to new
long run equilibrium (point A to B).
y
(n+d)k
y=f(k)
y3
s’y
y0 B
sy

Change in the population growth:

Increasing in the population

0 k
growth from n to n’ rotate the capital widening line from
k0 k3
(n+d)k to (n’+d)k. Since the more worker, saving per worker becomes smaller fall
from sy0 to sy4, then k decline from k0 to k4 and out per worker decline from y 0.to y4.
and the economy move to new steady state from point A to point C. Figure (8)
describes the change in population growth and its effect on economic growth.

(n’+d)k
y
(n+d)k
y=f(k)

y0
sy
y4
sy0 A
C
sy4

0 k4 k0
k

Technical Change in the Solow Model

The Solow model in this point described the interrelationship between savings,
investment, population growth, output, and economic growth.

Production function modify as follows:

4
 Y = F(K, T x L)

Where: T = technological progress or efficiency of labor;

(T x L) = effective units of labor

If technology grows exogenously at rate ∆T/T = Ø, and workforce grow at n, then the
effective supply of labor is (n+ Ø). In other word, if technology is growing 1 % per
year and workforce (population) growing 2 %, then the effective supply of labor
increasing by 3 % per year.

We express the output with term of per effective worker:

Y/(T x L) = ye

Capital per effective worker:

K/(T x L) = (ke)

We write the production: ye=f(ke)

Saving per effective worker: sye , with effective labor now growing at the rate n+ Ø,
then the capital accumulation is

∆ ke = sye (n+d+ Ø) ke ………………………………….. (14)

The equation still show the steady-state point at which saving per effective worker is
equal to the amount of new capital to compensate for change in the size of the
workforce, depreciation, and technological change (sye =(n+d+Ø)k), to keep capital per
effective worker constant. This is shown in Figure (9) as follows:

ye (n+d+Ø)k
ye = f(ke)

ye0
sye

sye0
A

0
ke0 ke

5
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