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The Uzawa Two-Sector
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Contact "[Uzawa] finds that his model economy is always
stable...if the consumption-goods sector is more
capital-intensive than the investment-goods sector.
It seems paradoxical to me that such an important
characteristic of the equilibrium path should depend
on such a casual property of the technology. And
since this stability property is the one respect in
which Uzawa's results seem qualitatively different
from those of my 1956 paper on a one-sector
model, I am anxious to track down the source of
this difference."
(Robert M. Solow, "Note
on Uzawa", 1961, Review
of Economic Studies)
"It is evident that in all these constructions the
condition that the equilibrium at a moment in time
be unique is crucial. The rest of the story is really
concerned with ensuring that there is a steady state
with positive factor prices. But the assumptions
required to establish uniqueness of momentary
equilibrium are all terrible assumptions."
(Frank H. Hahn, "On Two-
Sector Growth Models",
1965, Review of Economic
Studies)
________________________________________________________
Contents
(1) Basic Setup
(2) Diagrammatic Representation
(3) Analytical Solutions
(A) Analytical Solution I: Classical Hypothesis
(B) Analytical Solution II: Proportional Savings
(4) Indeterminacy, Instability and Cycles
Selected References
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Two-sector extensions of the Solow-Swan growth model were introduced by Hirofum
Uzawa (1961, 1963), James E. Meade (1961) and Mordecai Kurz (1963). This led to
explosion of research in the 1960s, conducted primarily in the Review of Economic
Studies, on the two-sector growth model. Then, as suddenly as it had appeared, this l
of research evaporated in the 1970s.
(1) Basic Setup
Hirofumi Uzawa's (1961, 1963) two-sector growth model considers a Solow-Swan ty
of growth model with two produced commodities, a consumer good and an investme
good. Both these goods are produced with capital and labor. So we have two outputs
two inputs, of which the most interesting feature is that one of the outputs is also an
input. To use the old Hicksian analogy, in the Uzawa two-sector model, we are using
labor and tractors to make corn and tractors. For the following exposition, we have
benefited particularly from Burmeister and Dobell (1970) and Siglitz and Uzawa (19
Let us follow the basic setup of the Uzawa two-sector model. We begin with the
following definitions:
Yc = output of consumer good
Lc = labor used in consumer good sector
Kc = capital used in consumer good sector
Yi = output of investment good
p = price of investment good (in terms of consumer good)
Li = labor used in investment good sector
Ki = capital used in investment good sector
Y = total output of economy
L = total supply of labor
K = total supply of capital
w = return to labor (wages)
r = return to capital (profit/interest)
The principal equations of the two-sector model can thus be set out as follows:
Yc = Fc(Kc, Lc) - consumer sector production function (1)
Yi = Fi(Ki, Li) - investment sector production
(2)
function
Y = Yc + pYi - aggregate output (3)
Lc + Li = L - labor market equilibrium (4)
Kc + Ki = K - capital market equilibrium (5)
w = dYc/dLc =
- labor market prices (6)
p·(dYi/dLi)
r = dYc/dKc =
- capital market prices (7)
p·(dYi/dKi)
gL = n - labor supply growth (8)
gK = Yi/K - capital supply growth (9)
These equations should be self-evident. The consumer goods sector and the investme
goods sector each use both capital and labor to produce their output. We capture this
equations (1) and (2), where Fc(·) is the consumer goods industry production functio
and Fi(·) the investment goods industry production function. Both production functio
Fc(·) and Fi(·) are nicely "Neoclassical", in the sense of exhibiting constant returns to
scale, continuous technical substitution, diminishing marginal productivities to the
factors, etc.
Equation (3) is merely the definition of aggregate output, expressed in terms of the
consumer good. Equations (4) and (5) are also self-evident: the market demand for la
is Lc + Li and the market demand for capital is Kc + Ki. As L and K are the respectiv
supplies, then (4) and (5) are merely the factor markets equilibrium conditions so tha
demand equals supply in each market.
Now, we assume no barriers competition in the factor markets, so that there is free
movement of labor and capital across sectors. This implies that the wage rate w and t
profit rate r must be the same in both the consumer goods and investment goods indu
Neoclassical economic theory tells us that the marginal productivity schedules for ea
factor in each industry form those industries' demand functions for the factors. As su
in labor market equilibrium, the return to labor (w) must be equal to the marginal pro
of labor in the consumer goods sector (dYc/dLi) and the marginal product of labor in
investment goods sector p·(dYi/dLi). This is equation (6). Equation (7) asserts the
analogous condition in capital market equilibrium, i.e. that the rate of return on capit
is equal to the marginal product of capital in both sectors.
Finally, as the investment goods industry produces all the new capital goods in the
economy, then, ignoring depreciation, we can define the change in the total stock of
capital as that sector's output, i.e. dK/dt = Yi, so the growth rate of capital is gK =
(dK/dt)/K = Yi/K, which is equation (8). Labor supply is assumed to grow exogenou
the exponential rate n, thus the growth rate of labor is gL = (dL/dt)/L = n, which is
equation (9).
We would now like to express everything in intensive form, i.e. in per capita or per l
unit terms. This gets a bit tricky. But defining:
yc = Yc/L
l c = Lc/L
kc = Kc/Lc
¦ c(kc) = Fc(Kc, Lc)/Lc
yi = Yi/L
l i = Li/L
ki = Ki/Li
¦ i(ki) = Fi(Ki, Li)/Li
y = Y/L
k = K/L
Then equations (1)-(9) above can be converted to the following:
yc = l c¦c(kc) - consumer sector intensive
production function (1¢ )
yi = l i¦i(ki) - investment sector intensive
production function (2¢ )
y = yc + pyi - aggregate output per capita (3¢ )
lc+li=1 - labor market equilibrium (4¢ )
lckc + liki = k - capital market equilibrium (5¢ )
w = ¦ c - kc¦c¢
- labor market prices (6¢ )
= p·(¦ i - ki¦i¢ )
r = ¦c¢ = p·¦i¢ - capital market prices (7¢ )
gL = n - labor supply growth (8¢ )
gK = yi/k - capital supply growth (9¢ )
Equations (1¢ ) and (2¢ ) are the intensive production functions. These are derived as
follows. Recall from (1) that Yc = Fc(Kc, Lc), then dividing through by Lc, we obtain
Yc/Lc = Fc(Kc/Lc, 1) = ¦c(kc). But Yc/Lc = (Yc/L)(L/Lc) = yc/l c. Thus yc = l c¦c(kc
which is (1¢ ). The transformation from (2) to (2¢ ) follows a similar procedure.
Each of these intensive production functions have simple properties. For instance, th
first derivatives are the marginal product of capital, i.e. ¶ Fc/dKi = ¦c¢ (kc) and ¶ Fi/d
¦i¢ (ki), so diminishing marginal productivity implies ¦c¢¢ (kc) < 0 and ¦i¢¢ (ki) < 0.
The production functions also fulfill the famous "Inada conditions", formulated by K
Ichi Inada (1963). Specifically:
¦c(0) = 0, ¦c(¥ ) = ¥
¦c¢ (0) = ¥ , ¦c¢ (¥ ) = 0
for the intensive production function for the consumption good. The equivalent Inada
conditions apply to the intensive production function for the investment good:
¦i(0) = 0, ¦i(¥ ) = ¥
¦i¢ (0) = ¥ , ¦i¢ (¥ ) = 0
(see also our discussion of production functions).
Equations (3¢ ) and (4¢ ) are obtained merely by dividing (3) and (4) by L. Equation (
is obtained by dividing (5) by L, which yields Kc/L + Ki/L = K/L = k, but as Kc/L =
(Kc/Lc)(Lc/L) = kclc and Ki/L = (Ki/Li)(Li/L) = kili. So, lckc + l iki = k, as we have
(5¢ ).
Equations (6¢ ) and (7¢ ) use Euler's theorem. Now, it is a simple matter to show that
dYc/dKc = ¦c¢ (kc) and dYi/dKi = ¦i¢(ki). So, the competitive condition in (7) is conv
to r = ¦c¢ = p·¦i¢ . By constant returns to scale, we know from Euler's theorem that Y
(dYc/dK)·K + (dYc/dLc)·Lc, thus dividing through by L and rearranging: dYc/dLc =
(Yc/L) - (K/L)·(dYc/dK) = yc - k·¦c¢ . The corresponding transformation can be done
dYi/dLi. This is how we convert (6) to (6¢ ). Finally, equation (9¢ ) is obtained simply
multiplying (9) through by 1 = L/L, so gK = (Yi/L)/(K/L) = yi/k.
Now, following Uzawa's notation, let us define w (omega) as the wage-profit ratio, i.
= w/r. Thus, combining equations (6¢ ) and (7¢ ):
w = w/r = [¦ c(kc) - kc·¦c¢ ]/¦c¢ = [¦ i(ki) - ki·¦i¢ ]/¦i¢
or simply:
w = (¦ c(kc)/¦c¢ ) - kc = (¦ i(ki)/¦i¢ ) - ki
Now, notice that:
dw /kc = - ¦c¢¢ ·¦c(kc)}/(¦c¢ (kc))2 > 0
dw /ki = - ¦i¢¢ ·¦ i(ki)}/(¦i¢ (ki))2 > 0
Thus, w is positively related to kc and ki. It is not difficult to see that these are monot
relationships. Consequently we can define the functions:
kc = kc(w ) where kc¢ = (¦c¢ )2/(¦c¢¢ ·¦ c) > 0
ki = ki(w ) where ki¢ = (¦i¢ )2/(¦i¢¢ ·¦ i) > 0
which will be used extensively as they will form the boundaries of our equilibrium p
The growth story can be quickly told. At steady-state, the capital-labor ratio k must b
constant. As k = K/L, then:
gk = gK - gL
so, using our expression for gK and gL
(dk/dt)/k = yi/k - n
so:
dk/dt = yi - nk
Which is our fundamental differential equation. So, we have a steady-state where dk/
0.
Of course, this is not the end of the story, for we have yet to consider the question of
macroeconomic equilibrium. Specifically, note that while we have laid out the supply
consumer and investment goods, we have said nothing so far about the demand for th
outputs. As it turns out, this will depend crucially on the consumption-savings behav
of households. Specifically, the demand for consumer goods will depend on the amou
of income households consume, while the demand for investment goods will depend
the amount of savings. Now, we can follow the "Classical" economists and presume
all wages are consumed and all profits are saved (as Uzawa (1961) did); or we allow
some saving out of both wages and profits (as Uzawa (1963) allows) and we can eve
impose that the propensity to save out of these two categories of income is different (
Drandakis (1963) presumes).
Whatever the case, the model will not be closed until we consider the demands for
outputs explicitly. This is, after all, a Neoclassical model, which means that the
imputation theory should hold: output demands will determine output supplies and
consequently factor market equilibrium. Causality thus runs from preferences of
households to factor market equilibrium.
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