Solow Growth Model: Assignment# 1 Advance Macroeconomics

Muhammad Ali Jinnah
University
Assignment# 1
Advance Macroeconomics
Solow Growth Model
Submitted by: Sumair Gowani (SP19-MSEF-0015)

Submitted to: Dr. Rizwan ul Hassan
1
PART# 1
Professor R.M. Solow builds his model of economic growth as an alternative to the Harrod-
Domar line of thought without its crucial assumption of fixed proportions in production. Solow
postulates a continuous production function linking output to the inputs of capital and labour
which are substitutable.
Bob Solow has carried out some of the most important work in macroeconomics by creating the
Solow model of economic growth. Here is a summary of its key lessons:
 The more that people in an economy save of their income, the greater the amount of
investment. This leads to economic growth and higher future living standards.
 When the population growth rate falls, more capital is available for each person to use.
This increases income per person.
 When a firm uses a machine, it depreciates over time: that is, it’s not in as good a
condition at the end of the year as it was at the beginning. The slower that capital
(remember machines are capital) depreciates, the more capital exists per person and the
higher living standards are in an economy.
All these effects, however, are temporary. As the economy reaches its new ‘steady state’, it
stops growing again. Thus increasing savings, reducing the rate of population growth or
reducing the rate at which capital depreciates in an economy only temporarily increases
economic growth.
The only means to increase long-run living standards in the Solow model is through
continual technological progress, so economies need to get better at turning inputs (such as land,
labour and capital) into outputs (things that people want to buy).
Although Solow growth model is a theory of transition dynamics rather than a theory of long run
growth, the model assumes that technical change such as productivity growth is the key to long-
run growth of per capita income and output. In the Solow model, savings equals investment and
investment is a constant fraction of output which means we re-state the equation for changes in
the stock of capital.
2
Assumptions:
 One composite commodity is produced.
 Output is regarded as net output after making allowance for the depreciation of capital.
 There are constant returns to scale. In other words, the production function is
homogeneous of the first degree.
 The two factors of production, labour and capital, are paid according to their marginal
physical productivities.
 Prices and wages are flexible.
 There is perpetual full employment of labour.
 There is also full employment of the available stock of capital.
 Labour and capital are substitutable for each other.
 There is neutral technical progress.
 The saving ratio is constant.
Solow model was developed to explain long-term national economic growth in a more precise
manner. It is a unique theory and it varies from other economic development models since it
comprises of several equations to illustrate how production, capital goods, working time, as well
as investments influence each other.
Critics of this model.

Some of the critics discussed here include; in Solow model, technological advancement is the
only factor considered for long-term national economic growth but at diverse levels of revenue
based upon investments and population growth, and another limitation of this theory lies in
convergence of the progress of a national economy as discussed.
Precisely, Solow model is one of the unique theories that explain the long-term national
economic growth. In spite of its uniqueness, it has some significant limitations. The paper
discussed the meaning and major limitations of Solow model with respect to theory and
economic references.
Agreeably, the Solow model enlightens long-term economic growth based on technological
advancement, work, and majors on the national economy.
3
Weaknesses:
His “purpose was to examine what might be called the tight-rope view of economic growth and
to see where more flexible assumptions about production would lead a simple model.” Despite
this assertion by Solow, his model is weak in many respects, according to Prof. Amartya Sen.
1. The Solow model takes up only the problem of balance between Harrod’s Gw and Gn
and leaves out the problem of balance between G and Gw.
2. There is the absence of an investment function in Solow’s model and once it is

introduced, the Harrodian problem of instability quickly reappears by the Solow model.
Thus, according to Sen, the assumption of substitutability between labour and capital
does not seem to be a key difference between neo-classical and neo-Keynesian studies of
growth, and the main difference seems to lie in the investment function and the
consequent failure to assign a major role to entrepreneurial expectations about the future.
3. The Solow model is based on the assumption of labour-augmenting technical progress. It

is, however, a special case of Harrod-neutral technical progress of the Cobb-Douglas
production function type which does not possess any empirical justification.
4. Solow assumed flexibility of factor prices which may bring difficulties in the path
towards steady growth. For instance, the rate of interest may be prevented from falling
below a certain minimum level due to the problem of liquidity trap. This may, in turn,
prevent the capital-output ratio from rising to a level necessary for attaining the path of
equilibrium growth.
5. The Solow model is based on the unrealistic assumption of homogeneous and malleable
capital. As a matter of fact, capital goods are highly heterogeneous and thus pose the
problem of aggregation. Consequently, it is not easy to arrive at the steady growth path
when there are varieties of capital goods.
6. Solow leaves out the causative of technical progress and treats the latter as an exogenous
factor in the growth process. He thus ignores the problems of inducing technical progress
through the process of learning, investment in research, and capital accumulation.
4
PART# 2
In Capital and Labour, Labour is more important than capital because if we can make more profit
just deploy capital, people will deploy capital in those places where there is shortage of capital.
But Practically, Investors are investing more capital in those places where already a large amount
of capital has been deployed already.
Which is a proof that EFFICIENT LABOUR is more important than capital.

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Solow Growth Model: Assignment# 1 Advance Macroeconomics

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Muhammad Ali Jinnah

Solow Growth Model

Submitted by: Sumair Gowani (SP19-MSEF-0015)

Critics of this model.

2. There is the absence of an investment function in Solow’s model and once it is

3. The Solow model is based on the assumption of labour-augmenting technical progress. It

Which is a proof that EFFICIENT LABOUR is more important than capital.

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