The Solow Growth Model
In [Link], we saw how the Solow Model worked. Given a savings rate, a fraction of output per worker, and a depreciation
the economy generates an evolution, or time path. As the total change in capital per worker (k) is added to the
level of capital per worker, k, a new level of output per worker, y, and new levels of c and i are generated.
From i (= sy = sf(k)) minus depreciation (k) a new k is determined and the process begins again.
The evolution will settle down to a place where the values of k, y, c, and i are exactly repeated when k = 0. This steady-st
solution tells us the LEVELS of the endogenous variables k*, y*, c* and i*.
In [Link], we saw how k*, y*, c* and i* depend on s and then we explored finding the s that maximized c*
(which is called the Golden Rule).
In [Link], we focused on how population growth changes the circle of additional k via investment MINUS depreciatio
equals net additions to k because k is capital per worker and the number of workers is growing.
With population growth, even at the steady-state where y* is constant, Y (Real GDP) is constantly
growing (at the rate of growth of population).
So Real GDP, Y, can grow because of increases in k or increases in population.
Technological change is a third source of growth in the Solow Model. If the same amount of labor is more productive,
then output per worker will rise.
This workbook explores how technological change leads to economic growth via three sheets:
1) Understanding g explains the idea of efficiency units
This is CRUCIAL to understanding how technological progress is incorporated in the Solow Model.
Click on the link below to access the associated Word document for a more detailed explanation:
[Link]
2) EqPath presents the usual interface where you can explore the growth time path
Beware: Solver cannot be used to compare economies because of the efficiency units interpretation.
3) Omitting ng compares the exact and approximate (where the ng term is omitted) solutions
Omitting ng is getting pretty technical and nit-picky. The bottom line is that (1+n)*(1+g) = n + g + n
but ng is going to pretty small with reasonable values like n=0.01 and g=0.02.
worker, and a depreciation rate,
worker (k) is added to the existing
and i are generated.
begins again.
when k = 0. This steady-state
that maximized c*
vestment MINUS depreciation
s constantly
or is more productive,
ed in the Solow Model.
e detailed explanation:
ciency units interpretation.
at (1+n)*(1+g) = n + g + ng,
Population Growth A key and confusing concept when incorp
Lt+1 = (1+n)Lt is easy, right? Let's review. technological progress into the Solow Mo
that of "imaginary workers."
Suppose n = 0.01. If new technology means we get more ou
n 1% with the same number of workers, then i
Year L (millions) Formula we had more workers.
1 150 Labor in Efficiency Units incorporates bot
2 151.5 =(1+n)*B7 the fact that there are more workers whe
3 153.015 =(1+n)*B8 and the fact that it seems like we have m
Population is growing at rate n. workers when g > 0.
Why do this? Why interpret tech change
Good question. Because it's an easy way
Technological Change the model. We know how to handle n. If
Suppose population is constant, but labor productivity increases at g per year. tech change as like n, then we can solve
just like before.
Suppose n=0 and g = 0.02
n 0%
g 2%
Year L (millions) Efficiency Formula L in Eff Units Formula
1 150 1 150
2 150 1.02 =(1+g)*C20 153 =B21*C21
3 150 1.0404 =(1+g)*C21 156.06 =B22*C22
Population is constant, but L in Eff Units is growing at rate g.
Population Growth AND Technological Change
Suppose population grows at n per year and labor productivity increases at g per year.
Suppose n=0.01 and g = 0.02
n 1%
g 2%
Year L (millions) Efficiency L in Eff Units Formula Formula
1 150 1 150
2 151.5 1.02 154.53 =B33*C33 154.53 =(1+n)*(1+g)*D32
3 153.015 1.0404 159.196806 =B34*C34 159.196806 =(1+n)*(1+g)*D33
Population grows at n, but L in Eff Units grows at (approximately) n + g.
using concept when incorporating
rogress into the Solow Model is
ary workers."
gy means we get more output
number of workers, then it's as if
ncy Units incorporates both
ere are more workers when n > 0
at it seems like we have more
hy interpret tech change as more workers?
Because it's an easy way to solve
know how to handle n. If we treat
like n, then we can solve the model
The Solow Model Y = AKL and y = Ak where k = K/L and y = Y/L
Exogenous Variables
g 0.04 labor-aug tech change
n 0.03 population growth rate Endogenous Variables
A 9 technology parameter k capital per worker
alpha 0.1 capital exponent y output per worker
s 0.4 savings rate per worker c consumption per worker
0.7 depreciation rate per worker i investment per worker
initial k 4 k depreciation per worker
EXOGENOUS VAR SETTINGS NUMBER OF YEARS CS
Equilibrium (Steady-state)
Condition: k=0 Per worker(Real GDP per capita)
k for Imaginar
Year keff yeff %yeff ceff ieff
(+ n + g + ng)k next year y L Index y %y c
1 4.0000 10.3383 6.20297 4.13531 3.0848 0.98069 1 10.3383 6.20297
GDP per capita) Own Units (Real GDP)
12
i k Y %Y C I K 10
4.13531 4.0000 10.3383 6.20297 4.13531 4.0000
8
y
6
c
4 i
2
0
0.8 1 1.2 Year
1.4 1.6 1.8 2
12
10
8
y yeff
6
c ceff
i 4 ieff
2
0
1.8 2 0.8 1 1.2 Year
1.4 1.6 1.8 2
0
Increas es in k
0.8 1 1 .2
Ye a r
1.4 1.6 1.8 Decreas
2 es in k
Net Change in k
The Effect of Omitting ng Y = AKL and y = Ak where k = K/L and y = Y/L
Exogenous Variables
g 0.02 labor-aug tech change
n 0.01 population growth rate Endogenous Variables
k capital per worker
alpha 0.5 capital exponent y output per worker
s 0.3 savings rate per worker c consumption per worker
0.1 depreciation rate per worker i investment per worker
k depreciation per worker
The tables below compare the exact and approximate steady-state equilibrium conditions via Excel and reduced-form for k*:
Click on the cells in the table to reveal the formulas.
The exogenous variable values are those in the green cells above.
Exact Approximate
k=sy-(+n+g+ng)kk=sy-(+n+g)k
Math 5.3090955425 5.3254437870
Excel 5.3090955411 5.3254437865
So, we conclude the following:
The difference between Excel and Math is almost zero.
For both the Exact and Approximate models, the differences are really tiny:
Exact Approximate
k=sy-(+n+g+ng)kk=sy-(+n+g)k
Math - Excel 0.0000000014 0.0000000004
The difference between Exact and Approximate, where the latter omits the ng term, is very small.
Exact - Approximate
k=sy-(+n+g+ng)k - k=sy-(+n+g)k
Math -0.0163482445
Excel -0.0163482454
That's pretty small.
Of course, if you apply some big population increase (n) or tech progress (g) numbers, the approximation breaks down.
Four Questions
Neither Solver nor the Comp Statics Wizard cannot be used to perform a comparative statics analysis of the effect of g on y
Solver and the CSWiz will give the solution to the model in efficiency units, but you need the time path to know the effect o
1) If g increases, what happens to k*eff and y*eff?
Describe your procedure.
2) In your answer to the first question above, you found that y in efficiency units fell.
Does this mean the economy is performing worse as a result of labor-augmenting technologicalprogress?
This doesn't make sense.
What is going on?
3) Use the 1) Comp Statics button to perform a comparative statics analysis of the effect of g on y* and c*.
Write up your results.
Remember that k*eff and y*eff are not the same thing as k* and y*.
4) In the previous workbook ([Link]), you showed that the Solow model with g=0 predicts
that an increase in the rate of population growth leads to a decrease in k* and y*.
Does this result still hold when g=0.02?
Show this and explain your procedure.
statics analysis of the effect of g on y* and c*.
eed the time path to know the effect of a change in g on y* and c*.
ugmenting technologicalprogress?
ect of g on y* and c*.
g=0 predicts
