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Advanced Macro (Subject) / VL4 (Lesson)
- Population growth equation Lt=L0(1+g)t Lt=Population in time t L0=Population in period 0 g = constant growth rate t = the time period
- The Solow Growth Model Augments the production model with capital accumulation Capital stock is no longer exogenous Capital stock is now endogenized The accumulation of capital is a possible engine of long-run economic growth Cobb-Douglas production function, no state or net exports
- Capital Accumulation Kt+1=Kt+It-dKt d = depreciation rate, usually 0.07 - 0.1 change in capital is ΔKt+1=Kt+1-Kt = It - dKt Future capital depends on investment today
- Model dynamics When not in steady state, the economy exhibits a change in capital toward the steady state At the rest point, all endogenous variables are steady transition dynamics: take the economy from its initial level of capital to the steady state
- Relations of the steady state Positively related to investment (savings) rate the size of the workforce the productivity of the economy Negatively related to the depreciation rate
- Relations of the steady state Positively related to investment (savings) rate the size of the workforce the productivity of the economy Negatively related to the depreciation rate Higher steady state caused by higher productivity and investment rate, lower steady state caused by faster depreciation
- Why do economies reach the steady state? investment has diminishing returns the rate at which production and investment rise is smaller as the capital stock is larger depreciation is not diminishing as capital increases
- Strenghts and Weaknesses of the Solow Model Strenghts It provides a theory that determines how rich a country is in the long run (steady state) The principle of transition dynamics allows for an understanding of differences in growth rates across countries and why a country farther from the steady state will grow faster Weaknesses it focuses in investment and capital, the much more important factor of TFP is still unexplained it does not explain why different countries have different investment and productivity rates, a more complicated model could endogenize the investment rate the model does not provide a theory of sustained long-run economic growth
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