Question

If you consider the Solow model, once a country reaches the steady state, there is no growth. What is the only possible source of continuous economic growth in the Solow model? Explain.

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Answer 1

The Solow–Swan model is an economic model of long-run economic growth set within the framework of neoclassical economics. It attempts to explain long-run economic growth by looking at capital accumulation, labor or population growth, and increases in productivity, commonly referred to as technological progress.

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: 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 path, with 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.
• Neo-classical economists believe that to raise the trend rate of growth requires an increase in the labour supply + ahigher level of productivity of labour and capital.
• Differences in the pace of technological change between countries are said to explain much of the variation in growth rates that we see.

ONE IMPORTANT EXCEPTION

If (Cobb-Douglas P/N F/N), Y (t) = [AK (t) K (t)]α [AL(t)L(t)] 1−α , then both AK (t) and AL (t) could grow asymptotically, while maintaining balanced growth.

SUMMARY

• Output grows in the steady state through (exogenous) increases in labor force and productivity (g + n).
• Output per worker grows at the rate of productivity growth.
• Changes in the saving rate have level, not growth, effects on the steady-state growth path.
• Steady-state consumption per worker is maximized on the Golden Rule growth path where r = n + g, but this may or may not be optimal depending on how one weights current vs. future well-being.

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