Question

In: Economics

Verify that the following are true in the basic Solow growth model with no technological progress...

Verify that the following are true in the basic Solow growth model with no technological progress and no population growth:

(a) The real rate of return R/P is constant along the BGP

(b) The real wage W/P is constant along the BGP

(c) The capital to labor ratio K/N is constant along the BGP

(d) The capital to output ratio K=/Y is constant along the BGP

How do these results match up to the Kaldor and Kuznets stylized facts?

Solutions

Expert Solution

(a) In the case of no technological progress and no population growth, the real rate of return R/P might actually decline since there are diminishing returns. In order for output to grow, growth in productivity would be needed to maintain the real rate of return.

(b) The real wage W/P will remain constant along the BGP since there is no population growth, or workforce growth, and no technological changes to improve productivity.

(c) With a sustained rise in capital investment, the capital to labor ratio K/N will go up and this would increase the growth rate temporarily.

(d)The capital to output ratio K/Y will be constant along the BGP. The Solow growth model assumes that there are constant returns to scale. In such a case, if we double the level of capital investment, we would exactly double the level of output. Thus, the ratio, K/Y will remain constant.

Kaldor and Kuznet's stylized facts state the following in comparison to Solow -

1. Output per worker grows at a roughly constant rate and does not diminish over time. According to Solow, output per worker will diminish over time if there are no improvements in productivity.

2. Capital per worker grows over time. In continuation, Solow states that capital investment too has diminishing returns in the absence of technological advances.

3. The capital to output ratio is roughly constant. Solow's theory confirms this fact.

4. The rate of return to capital is constant. Solow states that rate of return to capital is diminishing in the absence of any technological progress.

5. The share of capital and labor in net income are nearly constant.

6. Real wage grows over time. Only if there's a growth in productivity as well.

Rahul Sunny answered 2 years ago
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