Robert Solow developed the neo-classical theory of economic growth and Solow won the Nobel Prize in Economics in He has made a huge contribution to our understanding of the factors that determine the rate of economic growth for different countries. Growth comes from adding more capital and labour inputs and also from ideas and new technology. Developing countries are now the engine driving the global economy, accounting for around two-thirds of global growth.
There are many differences across countries but there are some common elements to countries that have grown continuously. They have stable governments that pursue prudent economic policies, provide essential infrastructure and services, and take a long-term perspective. They use the opportunities provided by global markets and they have a dynamic and competitive private sector". The neo-classical model treats productivity improvements as an 'exogenous' variable — they are assumed to be independent of the amount of capital investment.
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What are the Main Limitations of the Solow Model? Essay
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Cart Account Log in Sign up. Economics Explore Economics Search Go. Economics Reference library. Developing countries are now the engine driving the global economy, accounting for around two-thirds of global growth There are many differences across countries but there are some common elements to countries that have grown continuously.
They use the opportunities provided by global markets and they have a dynamic and competitive private sector" Source: Jim Kim, President of World Bank, July What are the basic points about the Solow Economic Growth Model?
The Solow model believes that a sustained rise in capital investment increases the growth rate only temporarily : because the ratio of capital to labour goes up. However, the marginal product of additional units of capital may decline there are diminishing returns and thus an economy moves back to a long-term growth pathwith real GDP growing at the same rate as the growth of the workforce plus a factor to reflect improving productivity.
A 'steady-state growth path' is reached when output, capital and labour are all growing at the same rate, so output per worker and capital per worker are constant. Differences in the pace of technological change between countries are said to explain much of the variation in growth rates that we see.
Productivity growth The neo-classical model treats productivity improvements as an 'exogenous' variable — they are assumed to be independent of the amount of capital investment. Catch up growth The Solow Model features the idea of catch-up growth when a poorer country is catching up with a richer country — often because a higher marginal rate of return on invested capital in faster-growing countries. The Solow model predicts some convergence of living standards measured by per capita incomes but the extent of catch up in living standards is questioned — not least the existence of the middle-income trap when growing economies find it hard to sustain growth and rising per capita incomes beyond a certain level.
Subscribe to email updates from tutor2u Economics Join s of fellow Economics teachers and students all getting the tutor2u Economics team's latest resources and support delivered fresh in their inbox every morning. You're now subscribed to receive email updates! Print page. Related Collections. Economics Nobel Prize Collections. You might also like. Measuring Economic Growth Student videos.
Growth and Development Profile: Morocco Student videos.After you enable Flash, refresh this page and the presentation should play. Get the plugin now. Toggle navigation. Help Preferences Sign up Log in. To view this presentation, you'll need to allow Flash. Click to allow Flash After you enable Flash, refresh this page and the presentation should play. View by Category Toggle navigation. Products Sold on our sister site CrystalGraphics. Title: The Solow Growth Model.
Investment, s f k Tags: growth model solow stock. Latest Highest Rated. Title: The Solow Growth Model 1 No Transcript 2 The Solow Growth Model The Solow Growth Model is designed to show how growth in the capital stock, growth in the labor force, and advances in technology interact in an economy, and how they affect a nations total output of goods and services. Lets now examine how the model treats the accumulation of capital.
The Production Function The production function represents the transformation of inputs labor Lcapital Kproduction technology into outputs final goods and services for a certain time period. The algebraic representation is Y F KL 5 This assumption lets us analyze all quantities relative to the size of the labor force. So, from now on, lets denote all quantities in per worker terms in lower case letters. Here is our production functionwhere f k F k,1. The slope of the production function is the marginal product of capital if k increases by 1 unit, y increases by MPK units.
Diminishing Marginal Product of Capital 7 Investment savings. The rate of saving s is the fraction of output devoted to investment. Depreciation wearing out of old capital causes capital stock to fall. This equation relates the existing stock of capital k to the accumulation of new capital i.
For any level of k, output is f kinvestment is s f kand consumption is f k sf k. Below k, investment exceeds depreciation, so the capital stock grows. Investment, s f k i dk Above k, depreciation exceeds investment, so the capital stock shrinks.
If the saving rate is low, the economy will have a small capital stock and a low level of output. Investment and Depreciation Depreciation, d k Investment, s2f k Investment, s1f k i dk An increase in the saving rate causes the capital stock to grow to a new steady state. According to this equation, steady-state consumption is whats left of steady-state output after paying for steady-state depreciation.
It further shows that an increase in steady-state capital has two opposing effects on steady-state consumption. On the one hand, more capital means more output.It ensures steady growth in the long run period without any pitfalls.
Solow has dropped these assumptions while formulating its model of long-run growth. He has shown that if technical coefficients of production are assumed to be variable, the capital labour ratio may adjust itself to equilibrium ratio in course of time. This balance is established as a result of pulls and counter pulls exerted by natural growth rate Gn which depends on the increase in labour force in the absence of technical changes and warranted growth rate Gw which depends on the saving and investment habits of household and firms.
The knife edge balance established under Harrodian steady growth path can be destroyed by a slight change in key parameters. Solow retains the assumptions of constant rate of reproduction and constant saving ratio etc. In other words, according to Prof. Solow, the delicate balance between Gw and Gn depends upon the crucial assumption of fixed proportions in production.
The Solow Model of Growth: Assumptions and Weaknesses – Explained!
The knife edge equilibrium between Gw and Gn will disappear if this assumption is removed. Solow has provided solution to twin problems of disequilibrium between Gw and Gn and the instability of capitalist system.
In short, Prof. Solow has tried to build a model of economic growth by removing the basic assumptions of fixed proportions of the Harrod-Domar model. By removing this assumption, according to Prof. Solow, Harrodian path of steady growth can be freed from instability.
In this way, this model admits the possibility of factor substitution. The production takes place according to the linear homogeneous production function of first degree of the form. The above function is neo-classic in nature. There is constant returns to scale based on capital and labour substitutability and diminishing marginal productivities.
The constant returns to scale means if all inputs are changed proportionately, the output will also change proportionately. The relationship between the behaviour of savings and investment in relation to changes in output. It implies that saving is the constant fraction of the level of output. In this way, Solow adopts the Harrodian assumption that investment is in direct and rigid proportion to income. The growth rate of labour force is exogenously determined.
It grows at an exponential rate given by. The two factors of production are capital and labour and they are paid according to their physical productivities. Following these above assumptions, Prof. Solow tries to show that with variable technical co-efficient, capital labour ratio will tend to adjust itself through time towards the direction of equilibrium ratio. If the initial ratio of capital labour ratio is more, capital and output will grow more slowly than labour force and vice-versa.
To achieve sustained growth, it is necessary that the investment should increase at such a rate that capital and labour grow proportionately i. According to Prof. Solow, for attaining long run growth, let us assume that capital and labour both increase but capital increases at a faster rate than labour so that the capital labour ratio is high. As the capital labour ratio increases, the output per worker declines and as a result national income falls.
The savings of the community decline and in turn investment and capital also decrease. The process of decline continues till the growth of capital becomes equal to the growth rate of labour. Solow has assumed technical coefficients of production to be variable, so that the capital labour ratio may adjust itself to equilibrium ratio.Toggle navigation.
Key Points of the Solow Model of Economic Growth
Help Preferences Sign up Log in. View by Category Toggle navigation. Products Sold on our sister site CrystalGraphics. Title: The Solow Growth Model neo-classical growth model. Description: Increases in capital per worker lead to smaller and smaller increases in output An improvement in the state of technology shifts the production function up, Tags: classical growth lead model neo solow. Latest Highest Rated.
K capitalthe sum of all the machines, plants, and office buildings in the economy. N laborthe number of workers in the economy. The function F, tells us how much output is produced for given quantities of capital and labor.
Solow’s Model of Growth (With Diagram)
The better is technology, the higher is production for a given K and a given N. Well discuss technology further in lecture 13 4 Returns to Scale and Returns to Factors Constant returns to scale is a property of the economy in which, if the scale of operation is doubledthat is, if the quantities of capital and labor are doubledthen output will also double.
Or more generally, 5 Returns to Scale and Returns to Factors Decreasing returns to capital refers to the property that increases in capital lead to smaller and smaller increases in output as the level of capital increases.
Decreasing returns to labor refers to the property that increases in labor, given capital, lead to smaller and smaller increases in output as the level of labor increases. As capital per worker increases, so does output per worker. Though countries with a higher saving rate will have a higher level of output per capita. Sustained growth over long periods of time requires sustained technological progress.
Whether your application is business, how-to, education, medicine, school, church, sales, marketing, online training or just for fun, PowerShow. And, best of all, most of its cool features are free and easy to use. You can use PowerShow. Or use it to find and download high-quality how-to PowerPoint ppt presentations with illustrated or animated slides that will teach you how to do something new, also for free.
Or use it to upload your own PowerPoint slides so you can share them with your teachers, class, students, bosses, employees, customers, potential investors or the world.It has been seen that the original Harrod-Domar model hereafter, mentioned as H-D Model is rigid, light, one sector and specific with respect to three parameters.
Thus, on account of constant saving-income ratio, constant capital-output ratio and constant demand for labour on full employment, the H-D model becomes too rigid to be much use. But the H-D model becomes very useful if these conditions are relaxed. The parameters constant variables may be allowed to vary. We may vary the supply of labour and treat it as more flexible on full employment—this has been done by Mrs.
Joan Robinson and her colleagues in Cambridge. Again, we can take a varying band of values for capital-output ratio, thereby increasing the possibility of G w being equal to G n.
This is the position of Neo-classical models developed by R. Solow, T. Swan, J. Meade, Samuelson, H. Johanson, and others. This is the approach adopted by Kaldor and, therefore, we discuss his basic model first of all. There are two factors of production capital and labour K and L and thus only two types of income profits and wages P and W.
All profits are saved and all wages are consumed. There are constant returns to scale and production function remains unchanged over time. Capital and labour are complementary.
There is perfect competition as such the rates of wages and profits are same over different places. Besides, Kaldor took certain facts as the bases of his model and as a starting point; for example, according to him, there is no recorded tendency for a falling rate of growth of productivity; there is a continued increase in the amount of capital per worker; there is a steady rate of profit on capital at least in the developed country; there is no change in the ratio of profits and wages—a rise in real wages is only in proportion to the rise in labour productivity; the capital-output ratios are steady over long periods—this implies near identity in the percentage rates of growth of production and of the capital stock; there are appreciable differences in the rate of growth of labour productivity and of total output in different sectors or economies.
The equilibrium can be brought about only by a just and appropriate distribution of income. In other words, growth rate and income distribution are inherently connected elements. In his model, on the one hand, the relations of distribution of income determine the given level of saving or social saving and, therefore, investment and economic growth rate.
On the other hand, the achievement of this or definite growth rate requires a given level of investment and, therefore, of saving and hence, a corresponding distribution of income. This is necessary if equilibrium at a higher level of real investment is to be obtained. If the saving-income ratio did not rise, the result would be a continuous upward movement of the general level of prices.
This is illustrated by the given Fig. In the Fig. The ratio of investment to income depends upon exogenous outside factors and is assumed as independent altogether. Since, propensities to save for the two income classes differ the mps out of profit income are more than the mps out of wage income.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. This paper discusses the meaning and major limitations of Solow model with respect to the available theories and economic references.
The model is based on three major assumptions. First, the two factors of production capital and efficient labor possess perpetual returns to scale. Labor as well as knowledge develops exogenously at considerable rates. This means that the number of effectual labor units will grow at a rate given by the sum of population growth n and Output per worker g.
Secondly; it assumes that other inputs apart from capital, labor and knowledge are not significant. The fundamental explanation of the Solow model is that simply the promptness of the technical growth is lasting for significant durable economic advancement. Thus, political advancement can only be fruitful in the long run so long as it favors the technical advancement. The Solow model enlightens long-term economic growth based on technological advancement, work, and majors on the national economy.
The fundamental support is that economic progression converges on a lasting foundation against equilibrium, where the investments into the capital stock become equivalent to the writings-off from the capital stock.
This support is reasonable, because in this equilibrium the discarded machines are instantaneously exchanged with new ones. This implies that, the national economy will develop provided that the investments are greater than the writings-off and the reverse will also be true. In addition, approval is attained to the degree that the pro head capital stock descends with increasing population growth, because the available revenue has to be distributed on more people. Furthermore, the rate of the technical development is shown in the domestic economy.
This lets the available capital stock to come to be obsolete Krugmanp.
This model is also known as neoclassical growth model. It is 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.
It is based on the fact that different nations use their resources effectively, and with increase in labor, there is a decline in returns. In addition, Solow model indicates that technology is a very significant factor for economic growth, and capital grows with improvement in technology. As a result the investments of a country increase and then it realizes an overall economic development. Also, it determines that the advancement on each and every national economy meets against a point provided on a long-lasting basis by the investments put into the national economy.
The continuous writing-off rate is dependent on population increase as well as the rate of technological advancement. Therefore, for long-term development in the national economy, there have to be technological advancement Rayp.
There have been numerous denunciations of Solow model, most of them associated with its combined and wholly supply-side nature. It is not practical to explain all economic production in just a single production function Solowp. Besides, aggregate capital stock can never be symbolized by one function as in the Solow model Solowp. There are several various kinds of output, most of which are never included in the typical GDP accounts, and investments assume several different forms.Professor R.The Solow Model and the Steady State
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. In other words, the production function is homogeneous of the first degree. Given these assumptions Solow shows in his model that with variable technical coefficient there would be a tendency for capital-labour ratio to adjust itself through time in the direction of equilibrium ratio.
If the initial ratio of capital to labour is more, capital and output would grow more slowly than labour force and vice versa. Solow takes output as a whole, the only commodity, in the economy. Its annual rate of production is designated as Y t which represents the real income of the community, part of it is consumed and the rest is saved and invested. That which is saved is a constant s, and the rate of saving is sY t.
K t is the stock of capital. Thus net investment is the rate of increase of this stock of capital, i. So the basic identity is. Since output is produced with capital and labour, technological possibilities are represented by the production function. Since population is growing exogenously, the labour force increases at a constant relative rate n.
The right hand side of equation 4 shows the compound rate of the growth of labour force from period 0 to period t. The labour supply curve is a vertical line, which shifts to the right in time as the labour force grows according to 4. Then the real wage rate adjusts so that all available labour is employed, and the marginal productivity equation determines the wage rate which will actually rule.
He regards this basic equation as determining the time path of capital accumulation, K, that must be followed if all available labour is to be fully employed. Once the time paths of capital stock and of the labour force are known, the corresponding time path of real output can be computed from the production function. In order to find out if there is always a capital accumulation path consistent with any rate of growth of the labour force towards steady state, Professor Solow introduces his fundamental equation.
The function sF r, 1 represents output per worker as a function of capital per worker. In other words, it is the total product curve as varying amounts r of capital are employed with one unit of labour. The equation 6 itself states that the rate of change of capital-labour ratio r is the difference of two terms, one representing the increment of capital [sF r, 1 ] and the other increment of labour nr. Solow illustrates diagrammatically possible growth patterns based on his fundamental equation 6.
In Fig. The other curve represents the function sF r, 1. It is so drawn as to show diminishing marginal productivity of capital. Assuming constant returns to scale, real output will also grow at the same relative rate n, and output per head of labour force will be constant. At r there will be the balanced growth equilibrium. What will be the behaviour of the capital-labour ratio if there is a divergence between r and r.
If the initial ratio is above the equilibrium value, capital and output will grow more slowly than the labour force. The growth of output is always intermediate between those of labour and capital. But the strong stability shown in the above figure is not inevitable.
It depends on the shape of the productivity curve sF r, 1. But r 1 and r 3 are stable equilibrium positions because the total productivity curve sF r, 1 is above nr but at r 2 it is below nr. Therefore, r 2 is an unstable equilibrium position. In either case labour supply, capital stock and real output will asymptomatically expand at rate n, but around r 1 there is less capital than around r 3hence the level of output per head will be lower in the former case than in the latter.