1) The Solow growth model describes how capital per worker (k) changes over time based on investment, depreciation, and population growth. It identifies a "steady state" capital level and "Golden Rule" that maximizes consumption.
2) Endogenous growth theory models how technological progress and investment can lead to sustained long-run economic growth, unlike the exogenous growth in Solow's model. It features constant or increasing returns to scale.
3) Both models analyze factors like savings rates, depreciation, and population growth that influence capital accumulation and economic output over time.
1) The Solow growth model describes how capital per worker (k) changes over time based on investment, depreciation, and population growth. It identifies a "steady state" capital level and "Golden Rule" that maximizes consumption.
2) Endogenous growth theory models how technological progress and investment can lead to sustained long-run economic growth, unlike the exogenous growth in Solow's model. It features constant or increasing returns to scale.
3) Both models analyze factors like savings rates, depreciation, and population growth that influence capital accumulation and economic output over time.
1) The Solow growth model describes how capital per worker (k) changes over time based on investment, depreciation, and population growth. It identifies a "steady state" capital level and "Golden Rule" that maximizes consumption.
2) Endogenous growth theory models how technological progress and investment can lead to sustained long-run economic growth, unlike the exogenous growth in Solow's model. It features constant or increasing returns to scale.
3) Both models analyze factors like savings rates, depreciation, and population growth that influence capital accumulation and economic output over time.
1) The Solow growth model describes how capital per worker (k) changes over time based on investment, depreciation, and population growth. It identifies a "steady state" capital level and "Golden Rule" that maximizes consumption.
2) Endogenous growth theory models how technological progress and investment can lead to sustained long-run economic growth, unlike the exogenous growth in Solow's model. It features constant or increasing returns to scale.
3) Both models analyze factors like savings rates, depreciation, and population growth that influence capital accumulation and economic output over time.
Dr. My Nguyen I. The Solow model • The production function: In aggregate terms: Y = F (K, L) • Define: y = Y/L = output per worker k = K/L = capital per worker • Assume constant returns to scale: zY = F (zK, zL ) for any z > 0 • Pick z = 1/L. Then Y/L = F (K/L, 1) y = F (k, 1) y = f(k) where f(k) = F(k, 1) The national income identity • Y = C + I (remember, no G ) • In “per worker” terms: y=c+i where c = C/L and i = I /L • s = the saving rate, the fraction of income that is saved (s is an exogenous parameter) • Consumption function: c = (1–s)y (per worker) Saving and investment • saving (per worker) = y – c = = • National income identity is y = c + i Rearrange to get: i = y – c = sy Using the results above, i = Capital accumulation • The basic idea: Investment increases the capital stock, depreciation reduces it. Change in capital stock = investment – depreciation • Δk = i – δk • Since i = sf(k) , this becomes: The equation of motion for k
• The Solow model’s central equation
• Determines behavior of capital over time… • …which, in turn, determines behavior of all of the other endogenous variables because they all depend on k. E.g., income per person: y = f(k) consumption per person: c = (1 – s) f(k) The steady state
If investment is just enough to cover depreciation
[sf(k) = δk], then capital per worker will remain constant: Δk = 0.
This occurs at one value of k, denoted k*,
called the steady state capital stock. The Golden Rule: Introduction • Different values of s lead to different steady states. How do we know which is the “best” steady state? • The “best” steady state has the highest possible consumption per person: c* = (1–s) f(k*). • An increase in s • leads to higher k* and y*, which raises c* • reduces consumption’s share of income (1–s), which lowers c*. • So, how do we find the s and k* that maximize c*? The Golden Rule capital stock • k gold the Golden Rule level of capital, the steady state value of k *
that maximizes consumption.
• To find it, first express c* in terms of k*: c* = y* − i* = f (k*) − i* = f (k*) − δk*
• In the steady state: i* = δk* because Δk = 0.
The transition to the Golden Rule steady state • The economy does NOT have a tendency to move toward the Golden Rule steady state. • Achieving the Golden Rule requires that policymakers adjust s. • This adjustment leads to a new steady state with higher consumption. • But what happens to consumption during the transition to the Golden Rule? Population growth • Assume the population and labor force grow at rate n (exogenous): L n L
• EX: Suppose L = 1,000 in year 1 and the population is growing at 2%
per year (n = 0.02). • Then ΔL = nL = 0.02×1,000 = 20, so L = 1,020 in year 2. Break-even investment • (δ + n)k = break-even investment, the amount of investment necessary to keep k constant. • Break-even investment includes: • δ k to replace capital as it wears out • nk to equip new workers with capital (Otherwise, k would fall as the existing capital stock is spread more thinly over a larger population of workers.) The equation of motion for k The Golden Rule with population growth To find the Golden Rule capital stock, express c* in terms of k*: c* = y* − i* = c* is maximized when MPK = or equivalently, Technological progress in the Solow model • A new variable: E = labor efficiency • Assume: Technological progress is labor-augmenting: it increases labor efficiency at the exogenous rate g:
E g E Technological progress in the Solow model • We now write the production function as: Y F (K , L E ) where L × E = the number of effective workers. Increases in labor efficiency have the same effect on output as increases in the labor force. Technological progress in the Solow model • Notation: y = Y/LE = output per effective worker k = K /LE = capital per effective worker • Production function per effective worker: y = f(k) • Saving and investment per effective worker: sy = sf(k) Technological progress in the Solow model (δ + n + g)k = break-even investment: the amount of investment necessary to keep k constant. Consists of: • δ k to replace depreciating capital • n k to provide capital for new workers • g k to provide capital for the new “effective” workers created by technological progress The Golden Rule with technological progress To find the Golden Rule capital stock, express c* in terms of k*: c* = y* − i* = c* is maximized when
or equivalently, II. Endogenous growth theory • Solow model: • sustained growth in living standards is due to tech progress. • the rate of tech progress is exogenous. • Endogenous growth theory: • a set of models in which the growth rate of productivity and living standards is endogenous. II. Endogenous growth theory • Production function: Y = AK where A is the amount of output for each unit of capital (A is exogenous & constant) • Key difference between this model & Solow: MPK is constant here, diminishes in Solow • Investment: sY • Depreciation: δK • Equation of motion for total capital: ΔK = sY − δK II. Endogenous growth theory • ΔK = sY − δK Y K • Divide through by K and use Y = AK to get: sA Y K If sA > δ, then income will grow forever, and investment is the “engine of growth.” Here, the permanent growth rate depends on s. In Solow model, it does not.
