THEORIES OF
GROWTH: THE SOLOW
GROWTH MODEL
ROMER: CHAPTER 1
MODEL BACKGROUND
• The Solow growth model is the starting point to determine why growth differs across
similar countries.
• it builds on the Cobb-Douglas production model by adding a theory
of capital accumulation
• developed in the mid-1950s by Robert Solow of MIT, it is the basis for
the Nobel Prize he received in 1987
• the accumulation of capital is a possible engine of long-run economic
growth
BUILDING THE MODEL: GOODS
MARKET SUPPLY
• We begin with a production function and assume constant
returns.
Y=f(K,L) so… zY=f(zK,zL)
• By setting z=1/L it is possible to create a per worker
function.
• Y/L=f(K/L,1)
• So, output per worker is a function of capital per worker.
y=f(k)
BUILDING THE MODEL: GOODS
MARKET SUPPLY
• The slope of this function is change in y
y
MPK
the marginal product of change in k
capital per worker. y=f(k)
• It tells us the change in Change in y
output per worker that
results when we increase Change in k
the capital per worker by
one.
k
BUILDING THE MODEL: GOODS
MARKET DEMAND
• Beginning with per worker consumption and investment (Government
purchases and net exports are not included in the Solow model), the
following per worker national income accounting identity can be obtained:
y = c+i
• Given a savings rate (s) and a consumption rate (1–s) a consumption function
can be generated:
c = (1–s)y …which is the identity. Then
y = (1–s)y + i …rearranging,
i = s*y …so investment per worker
equal savings multiplied by output per worker.
• By substituting f(k) for (y), the investment per worker function (i = s*y)
becomes a function of capital per worker (i = s*f(k)).
OUTPUT CONSUMPTION AND INVESTMENT
DEPRECIATION AND CAPITAL CHANGE
By adding a depreciation rate (d).
•The impact of investment and depreciation on capital can be
developed to evaluate the need of capital change:
•Δk = i – dk
•…substituting for (i)
• Δk = s*f(k) – dk
DEPRECIATION AND CAPITAL CHANGE
THE STEADY STATE EQUILIBRIUM
STEADY STATE EQUILIBRIUM
The Solow model long run equilibrium occurs at the point
where both (y) and (k) are constant.
The endogenous variables in the model are y and k.
The exogenous variable is (s).
CHANGING THE EXOGENOUS VARIABLE -
SAVINGS
Investment,
Depreciation
• We know that steady state dk
s*f(k*)=dk*
is at the point where s*f(k)
s*f(k)=dk
• What happens if we s*f(k*)=dk* s*f(k)
increase savings?
• This would increase the
slope of our investment k
k* k**
function and cause the
function to shift up.
• This would lead to a higher
steady state level of capital.
• Similarly a lower savings
rate leads to a lower steady
state level of capital.
WE CAN SEE WHAT HAPPENS TO OUTPUT, Y,
AND THUS TO GROWTH IF WE RESCALE THE
VERTICAL AXIS:
Investment, •Saving = investment and
Depreciation, Income depreciation now appear
here
Y* •Now output can be
graphed in the space
above in the graph
•We still have transition
dynamics toward K*
•So we also have
dynamics toward a
steady-state level of
income, Y*
Capital, Kt
K*
POPULATION GROWTH IN THE SOLOW MODEL
KEY POINTS
The Solow Growth model is a dynamic model that allows
us to see how our endogenous variables capital per
worker and output per worker are affected by the
exogenous variable savings.
We also see how parameters such as depreciation enter
the model, and finally the effects that initial capital
allocations have on the time paths toward equilibrium.
The Solow growth model shows that in the long
run, an economy’s rate of saving determines
the size of its capital stock and thus its level
of production.
The higher the rate of saving, the higher the
stock of capital and the higher the level of output.
Titolo Presentazione 18/10/2024
In the Solow model, an increase in the rate of saving has a level
effect on income per person: it causes a period of rapid growth, but
eventually that growth slows as the new steady state is reached.
Thus, although a high saving rate yields a high steady-state level of
output, saving by itself cannot generate persistent economic
growth.
The level of capital that maximizes steady-state consumption is
called the Golden Rule level.
Titolo Presentazione 18/10/2024
The Solow model shows that an economy’s rate of
population growth is another long-run
determinant of the standard of living.
According to the Solow model, the higher the
rate of population growth, the lower the
steady-state levels of capital per worker and
output per worker.
Malthus suggested that population growth will strain the
natural resources necessary to produce food
Kremer suggested that a large population may promote
technological progress.
