Running Head: The Solow Model Unleashed: Understanding Economic Growth

The Solow Model Unleashed: Understanding Economic Growth

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 The Solow Model Unleashed: Understanding
Economic Growth

Question 1

a).

All the inputs have been entered.

b).

All the inputs have been entered in France/US column.

c).

The different quantities have been computed for US and France.

d).

The entire tables have been filled up in sheets of US projected growth and France
projected growth.

Question 2

a).
 The information provided in exhibit 2 is not consistent with the information or the ratio
of output per capita of France over US that we have computed. This is shown as follows for the
year 1950 in the table below:

1950 US France
Y/Pop 18.5616 191.123
K/N 5 10
Output per capita 4 20
Ratio 20%

Exhibit 2 shows output per capita of France to US of 54% while our variables show that
it is actually 20%.

b).

First, if we look at the plot that has been generated in the excel spreadsheet for the output
per capital of France and US then we can see that huge margin and the gap between the output
per capital that is the economic growth between the two countries. This chart is shown below:
 UNITED STATES FRANCE

1000.000
Output per Capita - France
and US

100.000

10.000
1950 1960 1970 1980 1990 2000 2010 2020

The following points can be inferred:

i. If France had not suffered a large drop in its capital labor ratio during the war, then the
answer would have been different but not significantly and the output per capital would
have been higher for France as compared to US and with a higher ratio.
ii. The capital labor ratio is growing between 1950 and 1965 in France because of the
increase in the non-depreciated capital and the increase in the production each year that
increase the level of investment.
iii. The growth rate of capital labor ratio in France is slowing down between 1950 and 1965
because there are diminishing returns to the capital and the labor individually as the
amount of the single factor of production increases while all the other factors of
production remain constant.
 Question 3

a).

The role played by the total factor productivity is discussed below with responses to each
question:

i. The TFP growth rate currently is 0% and we can see that the output per capital for US has
not grown to a high level as compared to France, however, the output per capita in the
long run in US would not have reached to a fixed number but it would have grown at a
much higher rate than France because of the high employment to population ratio,
investment rate and population growth rate.
ii. The previous answer does not apply to the level of output instead of output per capita
because of the different growth rates for population and other factors.
iii. France would not have caught up or overtaken US in terms of output per capita because
of its lower growth rates of factors of production.
iv. If the TFP growth rate is assumed to be 2% for both the economies than both of them
follow an upward trend with respect to the output per capita and France has a higher
output per capita. The output per capital would have reached a fixed number applying the
law of diminishing returns. Moreover, the rate of production per capita is directly
dependent on the rate of TFP growth.
v. Productivity growth is highly important to achieve long run economic growth because it
combines all the factors of production under one umbrella and can can’t count only on
increasing the capital labor ratio as it is just a single factor of production.

b).

i. If the employment to population ratio of France had stayed constant at its 1950 level, then
the output per capital of France would have been significantly lower than that of US. This
 is also in line with the evidence provided in exhibit 1 in the case with the real GDP per
capita of US being higher. Similar is the case for the growth rates for output per capita.
ii. If the growth of employment to population ratio in France is based on these numbers,
then the output per capital in France would have increased in the short run that is the
years following 1955 as the growth rate would have been higher while in the long term it
would have decreased as the growth rate would have been low in the long run. The output
per capita in France would have decreased in the long run and yes this is consistent with
the evidence presented in exhibit 1.

c).

Based on our analysis, the output per capita and the TFP had been higher in France for
the years following the world war II however, it had declined later as a result of the law of
diminishing returns of the different factors of production and the employment to population ratio.
Grant Stone’s grandfather did not take this into account when forecasting the economic growth
in France. As a result, when he setup the operations of the business in France they impacted the
business of Durabuild Inc. in a similar fashion.

Question 4

a).

Assuming that the initial capital stock and the TFP for China is half of US we can
observe that the long run level and the growth rate of the output per capita in China relative to
US is significantly higher in the long run but lower in the short run as seen by the output per
capital graph. This is enough explanation for highlighting the differences between US and China
today.

b).
 The investment rate for US in 1950 was 30% and we have assumed the investment rate of
China to be 60%, then we can see that it has a direct impact on the TFP and the output per capita
over the long term while has minimal impact in the short term. The growth rate of output per
capita in long term is high.

c).

i. If we assume a population growth rate of 1% that is half of US, then we can see that there
is no impact on the TFP and the output per capita over the long term and also in the short
term.
ii. A decreasing population growth rate would increase the number of the working
individuals as compared to the individuals that would be retiring. As a result, the
employment to population ratio would increase in China and thus the impact of the lower
population growth rate would be that it would increase the growth rate of output per
capita in China relative to US significantly both in the medium and long term.