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Solow - Swan Model

The Solow-Swan model is an exogenous economic growth model that attempts to explain long-run growth through capital accumulation, labor growth, and technological progress. It predicts economies will converge to a steady-state equilibrium where permanent growth comes only from technological progress. The model assumes diminishing returns to capital and that savings rates determine only the level of income, not long-run growth rates.

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78 views13 pages

Solow - Swan Model

The Solow-Swan model is an exogenous economic growth model that attempts to explain long-run growth through capital accumulation, labor growth, and technological progress. It predicts economies will converge to a steady-state equilibrium where permanent growth comes only from technological progress. The model assumes diminishing returns to capital and that savings rates determine only the level of income, not long-run growth rates.

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Gabrijela
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Solow – Swan model

About the model


 exogenous economic model of long-run economic growth set within the framework of
neoclassical economics

 attempts to explain long-run economic growth by looking at capital accumulation, labor or


population growth, and increases in productivity (technological progress)

 developed by Robert Solow and Trevor Swan in 1956


Standard model

 standard Solow model predicts that in the long run, economies converge to their steady state
equilibrium and that permanent growth is achievable only through technological progress

 Both shifts in saving and in populational growth cause only level effects in the long-run (i.e. in
the absolute value of real income per capita)
 Implication of Solow's model is that poor countries should grow faster and eventually catch-up to
richer countries. This convergence could be explained by:

 Lags in the diffusion on knowledge. Differences in real income might shrink as poor countries
receive better technology and information

 Efficient allocation of international capital flows, since the rate of return on capital should be
higher in poorer countries. In practice, this is seldom observed

 A mathematical implication of the model (assuming poor countries have not yet reached their
steady state)
Assumptions

 Capital is subject to diminishing returns in a closed economy

 Given a fixed stock of labor, the impact on output of the last unit of capital accumulated will
always be less than the one before

 Assuming for simplicity no technological progress or labor force growth, diminishing returns
implies that at some point the amount of new capital produced is only just enough to make up
for the amount of existing capital lost due to depreciation. At this point, we can see the
economy ceases to grow.
 Assuming non-zero rates of labor growth complicate matters somewhat, but the basic logic still
applies – in the short-run, the rate of growth slows as diminishing returns take effect and the
economy converges to a constant "steady-state" rate of growth (that is, no economic growth per-
capita)

 Including non-zero technological progress is very similar to the assumption of non-zero


workforce growth, in terms of "effective labor": a new steady state is reached with constant
output per worker-hour required for a unit of output

 In this case, per-capita output grows at the rate of technological progress in the "steady-state"(that
is, the rate of productivity growth)
Mathematics of the model

 A single good (output) is produced using two factors of production, labor (L) and capital (K) in
an aggregate production function that satisfies conditions which imply that the elasticity of
substitution must be asymptotically equal to one

 t denotes time, 0<α<1 is the elasticity of output with respect to capital, and Y(t) represents total
production
 A refers to labor-augmenting technology or “knowledge”, thus AL represents effective labor
 All factors of production are fully employed, and initial values A(0), K(0), and L(0) are given
 The number of workers, i.e. labor, as well as the level of technology grow exogenously at rates n
and g, respectively:

 The number of effective units of labor, A(t)L(t) grows at rate (n+g)

 Stock of capital depreciates over time at a constant rate δ

 Only a fraction of the output cY(t) with 0<c<1 is consumed, leaving a saved share s=1-c for
investment.
 This dynamic is expressed through the following differential equation:

 Where K is the derivative with respect to time t

 Derivative with respect to time means that it is the change in capital stock—output that is neither
consumed nor used to replace worn-out old capital goods is net investment
 The main interest of the model is the dynamics of capital intensity k, the capital stock per unit of
effective labour. Its behaviour over time is given by the key equation of the Solow–Swan model:

 First term is actual investment per unit of effective labour

 Second term is is the “break-even investment”: the amount of investment that must be invested to
prevent k from falling
 The equation implies that k(t) converges to a steady-state value of displaystyle k*defined by

 at which there is neither an increase nor a decrease of capital intensity

 It is possible to calculate the steady-state of created wealth y* that corresponds with k*:
 Predicts that an economy will converge to a balanced-growth equilibrium, regardless of its
starting point
 In this situation, the growth of output per worker is determined solely by the rate of technological
progress
 By definition

 At the equilibrium k* :

 Capital/output ratio depends only on the saving, growth, and depreciation rates
 This is the Solow–Swan model's version of the golden rule saving rate
Thank you for the attention! 

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