Question

Consider the simple version of the Solow model we discussed, and focus specifically on the long run (steady state).

a. What variables within this model can increase the growth rate of output per capita? Explain the intuition behind each.

b. What variables within this model can increase the level of output per capita? Explain the intuition behind each. c. Which real-world factors that may be important for people’s prosperity are not included in our simple version of the Solow model? Briefly discuss them.

Answer 1

a.

Decline in the population growth rate can increase in the growth rate of output per capita in the long run. Such decline would shift the upward sloping depreciation line towards right. The new line then intersects the investment curve at a higher per capita capita and output level. So, fall in population growth rate leads to rise in the growth rate of output per capita (Y/L)

b.

The level of output per capita can be increased by rise in the savings rate or if there is any technological advancement. New technology allows expansion of production activities more efficiently and shifts the production possibility frontier to right. The output curve shifts upward representing the increase in output per capita.

Rise in savings rate raises output per capita only in the short run. Savings rate have level effects in the long run.

c.

Human Capital is not included in the simple version of Solow model. This factor play a major role in determining long term economic growth. The factor, is used by several economists like David Romer in their Economic Growth Models.

Simple version also takes technology as an exogenous variable. However, such a variable needs to be endogenized to see the actual effect on growth rates. Solow calls the impact of such variable on growth as "SOLOW RESIDUAL