Population Growth

The basic Solow model shows that capital accumulation,

by itself cannot explain sustained economic growth:

high rates of saving lead to high growth temporarily,

but the economy eventually approaches a steady state in
which capital and output are constant.

To explain the sustained economic growth observed in most

parts of the world,
the Solow model is expanded to incorporate the other two
sources of economic growth
—population growth and technological progress—
The Steady State With Population Growth

How does population growth affect the steady state?

To answer this question, we must discuss how population

growth, along with investment and depreciation,
influences the accumulation of capital per worker.

As we noted before, investment raises the capital stock, and

depreciation reduces it.

But now there is a third force acting to change the amount of

capital per worker—the growth in the number of workers—
causes capital per worker to fall
We continue to let lowercase letters stand for quantities per
worker. Thus,
k = K/L is capital per worker, and
y = Y/L is output per worker.
Keep in mind, however, that the number of workers is
growing over time.

The change in the capital stock per worker now is,

k = i − δk – nk
= i − (δ + n)k.
This equation shows how,
investment (i), depreciation (δk), and population
growth(nk) influence the per-worker capital stock.
Investment increases k, whereas depreciation and
population growth decrease k.

We can think of the term (δ + n)k as defining,

—break-even investment— the amount of investment
necessary to keep the capital stock per worker constant.

Break-even investment now includes:

- the depreciation of existing capital, which equals δk.

- and the amount of investment necessary to provide new

workers with capital — nk,
because there are n new workers for each existing worker
and because k is the amount of capital for each worker.
The equation of change in capital stock per worker

k = i − (δ + n)k.

shows that population growth reduces accumulation of

capital per worker much the way depreciation does.

Depreciation reduces k by wearing out the capital stock,

whereas,
population growth reduces k by spreading the capital
stock more thinly among a larger population of workers.
Our analysis with population growth now proceeds much
as it did previously.

First, we substitute sf(k) for i. The equation can then

be written as
k = sf(k) − (δ + n)k.

To see what determines the steady-state level of capital

per worker, we use Figure 7-11,
which extends the analysis of Figure 7-4 to include the
effects of population growth.

An economy is in a steady state if capital per worker k is

unchanging.
As before, we designate the steady-state value of k as k*.

If k is less than k*, investment is greater than

break-even investment, so k rises.

-If k is greater than k*, investment is less than

break-even investment, so k falls.

In the steady state, the positive effect of investment on the

capital stock per worker exactly balances the negative
effects of depreciation and population growth.

That is, at k*, k = i* − (δk* + nk*) = 0

and i* = δk* + nk*.
Once the economy is in the steady state, investment has
two purposes.

Some of it (δk*) replaces the depreciated capital,

and the rest (nk*) provides the new workers with the
steady-state amount of capital.
r2ec1*** The Effects of Population Growth

Population growth alters the basic Solow model in three

ways.

First, it brings closer to explaining

sustained economic growth.

In the steady state with population growth,

capital per worker and output per worker are
constant.
However, because the number of workers is growing
at rate n,
total capital and total output must also be growing
at rate n.

Hence, although population growth cannot explain

sustained growth in the standard of living
(because output per worker is constant in the steady state),

it can help explain sustained growth in total output.

Second, population growth gives another explanation
for why some countries are rich and others are poor.

Consider the effects of an increase in population growth.

Figure 7-12 shows that,

an increase in the rate of population growth
from n1 to n2
reduces the steady-state level of capital per worker
from k*1 to k*2.

Because k* is lower and because y* = f(k*), the level of

output per worker y* is also lower
Thus, the Solow model predicts that,
countries with higher population growth will have
lower levels of GDP per person.

Notice that a change in the population growth rate,

like a change in the saving rate,

has a level effect on income per person,

but does not affect the steady-state growth rate of

income per person.
Finally, population growth affects the criterion
for determining the Golden Rule
(consumption-maximizing) level of capital.

To see how this criterion changes, note that consumption

per worker is
c = y – i.

Because steady-state output y* is f(k*) and

steady-state investment i* is (δ + n)k*,
the steady-state consumption can be expressed as

c* = f (k*) − (δ + n)k*.
Using an argument largely the same as before (where
MPK is slope of the y curve and δ + n is the slope of
the (δ + n)k line),
we conclude that the level of k* that maximizes
consumption (the Golden Rule) is the one at which

MPK = δ + n,
or equivalently,

MPK – δ = n.

In the Golden Rule steady state,

the marginal product of capital net of depreciation
equals the rate of population growth.
Technological Progress in the Solow Model

So far, our presentation of the Solow model has assumed

an unchanging relationship between the inputs of capital

and labor, and the output of goods and services.

Yet the model can be modified,

to include exogenous technological progress,

which over time expands society’s production capabilities.
The Efficiency of Labor

The production function, thus far relates total capital K and

total labor L to total output Y,

Y = F(K, L).

To incorporate technological progress, we write the

production function as
Y = F(K, L × E),

where E is a new (and somewhat abstract) variable called

the efficiency of labor.
The efficiency of labor is meant to reflect society’s
knowledge about production methods:

as the available technology improves, the efficiency

of labor rises,

and each hour of work contributes more to the

production of goods and services.

The term L × E can be interpreted as measuring the

effective number of workers.
L × E considers the number of actual workers L and the
efficiency of each worker E.

In other words,
L measures the number of workers in the labor force,

whereas,
L × E measures both the workers and the technology,
with which the typical worker comes equipped.

This new production function (Y = F(K, L × E),

states that total output Y depends on the inputs of

capital K and effective workers L × E.
The essence of this approach to modeling technological
progress is that,

increases in the efficiency of labor E are analogous

to increases in the labor force L.

The simplest assumption about technological progress is

that,
it causes the efficiency of labor E to grow at some
constant rate g.
This form of technological progress is called
labor -augmenting,

and g is called the rate of labor-augmenting

technological progress.

Because the labor force L is growing at rate n,

and the efficiency of each unit of labor E is growing at

rate g,

the effective number of workers L × E is growing at rate

n + g.
The Steady State With Technological Progress

Because technological progress is modeled here as labor

augmenting,
it fits into the model in much the same way as population
growth.

Technological progress does not cause the increase in the

actual number of workers,

but it causes the increase in the effective number of

workers,
because each worker in effect comes with more units of
labor over time.
r2ec2*** We begin by reconsidering our notation.

Previously, when there was no technological progress, we

analyzed the economy in terms of quantities per worker;

now we can generalize that approach by analyzing the

economy in terms of quantities per effective worker.

We now let,

k = K/(L × E) stand for capital per effective worker and

y = Y/(L × E) stand for output per effective worker.
With these definitions, we can again write y = f(k).

The analysis of the economy proceeds, just as it did when

we examined population growth.

The equation showing the evolution of k over time

becomes
k = sf(k) − (δ + n + g)k.

As before, the change in the capital stock k equals

investment sf(k) minus breakeven investment (δ + n + g)k.
Now, however, because k = K/(L × E), break-even
investment in
k = sf(k) − (δ + n + g)k,

includes three terms, to keep k constant:

δk is needed to replace depreciating capital,

nk is needed to provide capital for new workers,

and gk is needed to provide capital for ‘the new

effective workers’, created by technological progress.

See Figure 8-1.

As shown in Figure 8-1,
the inclusion of technological progress does not
substantially alter our analysis of the steady state.

There is one level of k, denoted k*, at which,

capital per effective worker and output per effective

worker are constant.

As before, this steady state represents the long-run

equilibrium of the economy.
The Effects of Technological Progress

The table below shows how the four key variables behave
in the steady state with technological progress.
❖As we have just seen, capital per effective worker k
is constant in the steady state.

❖Because y = f(k), output per effective worker (y) is

also constant.

It is these quantities per effective worker that are

steady in the steady state.

From this information, we can also infer

what is happening to variables that are not expressed in
units per effective worker.
❖ For instance, consider output per actual worker
Y/L = y × E.

Because y is constant in the steady state and E is

growing at rate g,

output per worker must also be growing at rate g in the

steady state.

❖ Similarly, the economy’s total output is

Y = y × (E × L).
Because y is constant in the steady state, E is growing at
rate g, and L is growing at rate n,
total output grows at rate n + g in the steady state.
With the addition of technological progress, our model can
finally explain,

the sustained increases in standards of living that we

observe.

That is, we have shown that technological progress can

lead to sustained growth in output per worker.

By contrast, a high rate of saving leads to a high rate of

growth only until the steady state is reached.

Once the economy is in steady state, the rate of growth of

output per worker depends only on the rate of
technological progress.
With the addition of technological progress, our model can
finally explain

the sustained increases in standards of living that

we observe.

That is, we have shown that technological progress can

lead to sustained growth in output per worker.
The Golden Rule level of capital is now defined as,
the steady state that maximizes consumption per
effective worker.

Following the same arguments that we have used before

we can show that,

steady-state consumption per effective worker is

c* = f (k*) − (δ + n + g)k*.

Steady-state consumption is maximized

if MPK = δ + n + g,

or MPK − δ = n + g.
That is, at the Golden Rule level of capital,

the net marginal product of capital, MPK − δ,

equals the rate of growth of total output, n + g.

Because actual economies experience both population

growth and technological progress,

we must use this criterion to evaluate whether they have

more or less capital
than they would at the Golden Rule steady state.