The Solow-Swan Model

Alessandro Spiganti
Universitˋa Ca’ Foscari di Venezia

September 2021

Macroeconomics I
The Solow-Swan Model

- We start with a very simple neoclassical model

named after Robert Solow and Trevor Swan,
who introduced the model in 1956

- The Solow model is remarkable in its simplicity

- But it represented a breakthrough relative to

what came before

- A dynamic general equilibrium model

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Our Aims

1. Develop a simple framework for the proximate causes and the mechanism of
economic growth and cross-country income differences
2. Provide a benchmark against which to evaluate the contribution of more complex
models
3. Start thinking about the microfoundations of macroeconomic models

References: Acemoglu (2008, Chapter 2), Barro and Sala-I-Martin (1995, Chapter 1),
Romer (2019, Chapter 1)

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Proximate and Fundamental Causes

- What types of countries grow more rapidly?

- What are some possible motivations explaining the differences in average income
levels between e.g. US and Ghana?

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Growth and Physical Capital

- One obvious
candidate to look at is
investments in
physical capital

- There seems to be a
positive relationship
between growth and
investment rates

Average Growth Rates versus Average Investment to GDP Ratio, Various Countries
Source: Own elaboration with data from the Penn World Tables

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Roadmap

- The Solow Model in Discrete Time

- The Solow Model in Continuous Time

- The Solow Model and the Data

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The Solow Model in Discrete Time

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Framework: Settings and Households

- Consider a closed economy with a unique final good

- Discrete and infinite time, t = 0, 1, 2, . . . , ∞

- The economy is inhabited by a large number of households, who do not optimise

- All households are assumed identical, so we will consider a representative household

- Fundamental assumption of the Solow model: households save a constant fraction

s ∈ (0, 1) of their disposable income
- Let total income be Y (t ) and assume there is no government
- Total savings is S (t ) = sY (t )

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Framework: Production I

- All firms have access to the same production function so that we can simplify the
analysis by focusing on a representative firm with an aggregate production function

- The aggregate production function for the unique good is

Y (t ) = F (K (t ), A(t )L(t )) (1)

- K (t ) is capital but also is the final good of the economy, L(t ) is demand of labour, and
A(t ) is technology (or productivity) in t
- A(t )L(t ) is known as effective labour
- Technological progress in this form is known as labour-augmenting (or Harrod-neutral)

- Assumption: technology is free (publicly available as a non-excludable non-rival good)

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Why This Production Function?

- The production function F (K (t ), L(t ), A(t )) is too general for our purposes

- In particular, may not have a so-called balanced growth i.e. a path of the economy
consistent with the Kaldor facts (Kaldor, 1957)
- Output per capita has increased over time at a relatively constant rate (in US,
approximately 1.8% from 1870)
- Capital, investment, consumption, and output per capita have all grown at the same
constant rate
- The interest rate remains roughly constant (around 5%)
- The distribution of income between capital and labour remain roughly constant (at
around 1/3 and 2/3)

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Kaldor Facts I

Output per worker grows at a roughly constant rate that does not diminish over time
Source: Own elaboration with data from FRED
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Kaldor Facts II

log K/L is linear with slope approximately equal to 2%

Source: Own elaboration with data from the Penn World Tables
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Kaldor Facts III

Capital to Output Ratio is approximately constant

Source: Own elaboration with data from the Penn World Tables
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Kaldor Facts IV

The interest rate is approximately constant

Source: Own elaboration with data from the Penn World Tables
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Kaldor Facts V

The labour share is approximately 60%

Source: Own elaboration with data from the Penn World Tables
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Kaldor Facts VI

The capital share is approximately 30%

Source: Own elaboration with data from the Penn World Tables
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Types of Neutral Technological Progress I

- For some constant returns to scale function F̃

- Hicks-neutral technological progress

F̃ (K (t ), L(t ), A(t )) = A(t )F (K (t ), L(t ))

- Solow-neutral technological progress (capital-augmenting)

F̃ (K (t ), L(t ), A(t )) = F (A(t )K (t ), L(t ))

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Types of Neutral Technological Progress II

- For some constant returns to scale function F̃

- Harrod-neutral technological progress (labour-augmenting)

F̃ (K (t ), L(t ), A(t )) = F (K (t ), A(t )L(t ))

- A more general form

F̃ (K (t ), L(t ), A(t )) = AH (t )F (AK (t )K (t ), AL (t )L(t ))

- Balanced growth necessitates that all technological progress be labour augmenting or

Harrod-neutral

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Example: The Cobb-Douglas Production Function I

- The Cobb-Douglas formulation is

Y (t ) = K α (AL) β (2)

- If α + β < 1, there are decreasing returns to scale

- If α + β = 1, there are constant returns to scale
- If α + β > 1, there are increasing returns to scale
- The Cobb-Douglas production function is the simplest one consistent with constant
factor shares, under the additional assumption of competitive input markets
- We will often use this to characterise the equilibrium of our models
- Whenever possible though, we will try to work with a more general functional form

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Example: The Cobb-Douglas Production Function II

- The maximization problem of the firm is

π (w, R; A) = max K α (AL) β − ωL − RK

K ≥0,L≥0

- where ω and R are the wage rate and the rental price of capital

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Example: The Cobb-Douglas Production Function III

- From the first order conditions

βK α (AL) β Y ωL
ω = βAK α (AL) β−1 = =β → =β
L L Y
αK α (AL) β Y RK
R = αK α−1 (AL) β = = (1 − α ) → =α
K L Y
- Factor shares are equal to the constant output elasticities

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Framework: Production II

- Assumption 1: Continuity, Differentiability, Positive and Diminishing Marginal

Products, and Constant Returns to Scale
- The production function F is twice continuously differentiable in K and L and satisfies

∂F (·) ∂F (·)
FK (K , AL) ≡ >0 FL (K , AL) ≡ >0
∂K ∂L
∂2 F (·) ∂2 F (·)
FKK (K , AL) ≡ <0 FLL (K , AL) ≡ <0
∂K 2 ∂L2
- The production function F exhibits constant returns to scale in K and L, i.e. it is
homogeneous of degree 1 (or linearly homogeneous) in these two variables

F (zK , zAL) = zF (K , AL) for any constant z > 0

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Homogeneity and Euler’s Theorem

- Definition: Let K be an integer. The function g : IRK +2 → IR is homogeneous of

degree m in x ∈ IR and y ∈ IR if and only if

g (λx, λy, z ) = λm g (x, y , z ) for all λ ∈ IR+ and z ∈ IRK

- Euler’s Theorem: Suppose that g : IRK +2 → IR is continuously differentiable in x ∈ IR

and y ∈ IR, with partial derivatives denoted by gx and gy and is homogeneous of
degree m in x and y. Then

mg (x, y, z ) = gx (x, y , z )x + gy (x, y, z )y for all x ∈ IR, y ∈ IR, z ∈ IRK

Moreover, gx (x, y, z ) and gy (x, y , z ) are themselves homogeneous of degree m − 1 in

x and y

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Framework: Production III

- Assumption 2: Inada conditions

- The production function F satisfies the Inada conditions

lim FK (·) = ∞ and lim FK (·) = 0 for all L > 0 and A

K →0 K →∞
lim FL (·) = ∞ and lim FL (·) = 0 for all K > 0 and A
L→0 L→ ∞

- It ensures the existence of interior equilibria

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Market Structure, Endowments, and Market Clearing I

- Markets are competitive and in equilibrium at all date

- A competitive general equilibrium model
- Labour market
- Households own all of the labour, and they supply it inelastically i.e. there is a fixed
supply of labour L̄(t ) irrespective of the wage rate ω (t )
- Labour market clearing condition

L̄(t ) = L(t ), ∀t (3)

- By Assumption 1 and the fact that the labour market is competitive, ω (t ) > 0

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Market Structure, Endowments, and Market Clearing II

- Capital market
- Households own the capital stock and they rent it to firms for a rental price of capital R (t )
- Capital market clearing condition

K s (t ) = K (t ), ∀t (4)

- Take households’ initial holdings of capital K (0) as given

- Households can increase their holdings of capital by saving
- Capital depreciates at rate δ i.e. of one unit of capital this period, only 1 − δ is left for next
period

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Market Structure, Endowments, and Market Clearing III

- Final good
- Normalise the price of the final good at all dates to P (t ) ≡ 1
- Usually we can normalise the price of only one commodity (e.g. one good in one period or
state), but here it will be sufficient to keep track of an interest rate across periods, r (t )
- One unit of the final good can be consumed now or used as capital and rented to firm
- In the former case, one unit is consumed
- In the latter case, the household receives R (t ) in the next period but loses δ units due to
depreciation
- The interest rate faced by the household will thus be

r (t ) = R (t ) − δ (5)

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Optimal Production Decisions

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Optimal Production Decisions I

- The representative firm chooses capital and labour to maximize profits

- Since investments are not irreversible and there are no costs of adjustments, the
production side can be represented as a static profit maximisation problem

max F (K (t ), A(t )L(t )) − ω (t )L(t ) − R (t )K (t )

K (t )≥0,L(t )≥0

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Optimal Production Decisions II

- First-order conditions imply that the rental rates are equal to the marginal products

ω (t ) = FL (K (t ), A(t )L(t )) (6a)

R (t ) = FK (K (t ), A(t )L(t )) (6b)

- This, combined with Euler’s Theorem, implies

Y (t ) = ω (t )L(t ) + R (t )K (t ) (7)

- firms make zero profits

- total income is distributed among factors of production

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Laws of Motion

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Fundamental Laws of Motion of the Solow Model I

- Capital evolves over time according to

K (t + 1) = (1 − δ )K (t ) + I (t ) (8)

- where I (t ) is aggregate investment in t

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Fundamental Laws of Motion of the Solow Model II

- Total output can be either invested or consumed

Y (t ) = C (t ) + I (t ) (9)

- where C (t ) is aggregate consumption in t

- This is equivalent to the account identity of undergraduate macroeconomics
- It is a resource constraint
- The economy is closed and there is no government spending, therefore

S (t ) = I (t ) = Y (t ) − C (t ) (10)

- Recall S (t ) = sY (t ) by assumption (this is a behavioural rule)

- Thus C (t ) = (1 − s )Y (t )

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Fundamental Laws of Motion of the Solow Model III

- The fundamental law of motion of the Solow model can thus be written as

K (t + 1) = (1 − δ)K (t ) + sF (K (t ), A(t )L(t )) (11)

- This is a non-linear difference equation

- This equation, together with laws of motion for L(t ) and A(t ), completely describes
the Solow model

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Definition of Equilibrium

- The Solow model is a mixture of an old-style Keynesian model and a modern dynamic
macroeconomic model
- Households do not maximise
- But firms maximise and markets clear
- Definition of Equilibrium:
- For a given sequence of {L(t ), A(t )}t∞=0 and an initial capital stock K (0), an equilibrium
path of the baseline Solow model is a sequence of capital stocks, output levels,
consumption levels, wages and rental rates {K (t ), Y (t ), C (t ), ω (t ), R (t )}t∞=0 such that
K (t ) satisfies (11), Y (t ) is given by (1), C (t ) is given by (1 − s )Y (t ), and ω (t ) and R (t )
are given by (6a) and (6b)
- Note that it is an entire path of allocations and prices

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Equilibrium With Constant Population
and No Technological Progress
(in Discrete Time)

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Equilibrium I

- We make some further assumptions which will be relaxed later

- There is no population growth, i.e. L(t ) ≡ L
- There is no technological progress, i.e. A(t ) ≡ A
- Given the constant returns to scale assumption, we can write the production function
in intensive form  
K (t )
y (t ) = F , 1 ≡ f (k (t )) (12)
AL

- where y (t ) ≡ Y (t )/(AL) and k (t ) ≡ K (t )/(AL) are output and capital per efficiency unit
of labour

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Equilibrium II

- From Euler’s theorem

R (t ) = f 0 (k (t )) (13a)
ω (t ) = A f (k (t )) − k (t )f 0 (k (t ))
 
(13b)

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Equilibrium III

- We can also express the law of motion in (11) in intensive form by dividing both sides
by AL
k (t + 1) = sf (k (t )) + (1 − δ)k (t ) (14)
- Definition
- A steady-state equilibrium without technological progress and population growth is an
equilibrium path in which k (t ) = k ? for all t
- The economy will tend to this steady state equilibrium over time

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Equilibrium IV

- At the intersection,

k (t ) = k (t + 1) ≡ k ?

sf (k (t )) + (1 − δ)k (t ) = k (t )

f (k ? ) δ
- i.e. k? = s

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Equilibrium V

An alternative representation of the steady-state is the intersection of δk (t ) and the

function sf (k (t ))
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The Golden Rule I
- Note that c ? = (1 − s )f (k ? )
- If s increases, k ? increases as well
- But c ? may increase or decrease
- Write the steady-state relationship between c ? and s as

c ? (s ) = (1 − s ) f (k ? (s )) = f (k ? (s )) − sf (k ? (s )) = f (k ? (s )) − δk ? (s ) (15)

- Differentiate (15) with respect to s

∂c ? (s )  ∂k ? (s )
= f 0 (k ? (s )) − δ

(16)
∂s ∂s
- The maximum c ? is reached for ∂c ? (sgold )/∂s = 0, i.e.
 
f 0 kgold
?
=δ (17)

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The Golden Rule II

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The Golden Rule II

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Transitional Dynamics I

- Remember that the equilibrium is an entire path of capital stock, output, consumption,
and prices
- We thus need to study the transitional dynamics of the equilibrium difference equation
(14) starting from an arbitrary k (0) > 0

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Transitional Dynamics II

- Starting from initial capital

stock k (0) < k ? , the economy
grows towards k ?
- It experiences capital
deepening
- There is growth of per capita
income

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Transitional Dynamics II

- Starting from initial capital

stock k (0) < k ? , the economy
grows towards k ?
- It experiences capital
deepening
- There is growth of per capita
income

- If the economy starts with

k (0) > k ? , it reaches the
steady state by decumulating
capital and contracting

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Recap

- The Solow model has a number of attractive properties

- Unique steady state
- Global stability
- Simple and intuitive comparative statics
- In steady state, there is no growth in capital per effective unit of labour
- There is only growth along the transitional path to the steady state
- This is not sustained, as it dies out over time

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From Discrete to Continuous Time

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From Discrete to Continuous Time: Why?

- Modern macroeconomic models are set in either continuous and discrete time

- The continuous time setup has a number of advantages, like more flexibility and
allowing explicit-form solutions in a wider set of circumstances

- We will try to familiarise ourselves with both

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From difference to differential equations I

- Start with a simple difference equation

x (t + 1) − x (t ) = g (x (t )) (18)

- Now consider the following approximation for any ∆t ∈ [0, 1],

x (t + ∆t ) − x (t ) ≈ ∆t · g (x (t )) (19)

- When ∆t = 0, this is just an identity. When ∆t = 1, it gives (18)

- In-between it is a linear approximation, reasonably good if g (x ) ≈ g (x (t )) for all
x ∈ [x (t ), x (t + 1)]

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From difference to differential equations II

- Divide both sides of this equation by ∆t, and take limits

x (t + ∆t ) − x (t )
lim = g (x (t )) (20)
∆t →0 ∆t
| {z }
dx (t )
dt ≡ẋ (t )

- Equation (20) is a differential equation representing (18) for the case in which the
difference between t and t + 1 is “small”

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The Solow Model in Continuous Time: Reminder

- Reminder
- Savings are S (t ) = sY (t )
- Consumption is C (t ) = (1 − s )Y (t )
- Instantaneous wage rate is ω (t ) = FL (K (t ), A(t )L(t ))
- Instantaneous rental rate is R (t ) = FK (K (t ), A(t )L(t ))

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The Fundamental Laws of Motion in Continuous Time

- Relax some assumptions

- Population grows at rate n

L̇(t )
L(t ) = exp(nt )L(0) or, equivalently, =n (21)
L(t )

- Technology grows at rate g

Ȧ(t )
A(t ) = exp(gt )A(0) or, equivalently, =g (22)
A(t )

- The continuous time equivalent of the capital accumulation equation in (8) is

K̇ (t ) = I (t ) − δK (t ) = sF (K (t ), A(t )L(t )) − δK (t ) (23)

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The Solow Model in Continuous Time

- For convenience, we transform everything in intensive form

K (t )
k (t ) =
A(t )L(t )
 
Y (t ) K (t )
y (t ) = =F , 1 ≡ f (k (t ))
A(t )L(t ) A(t )L(t )

- How does k (t ) evolve over time?

k̇ (t ) K̇ (t ) Ȧ(t ) L̇(t ) sF (K (t ), A(t )L(t ))

= − − = −δ−g−n
k (t ) K (t ) A(t ) L(t ) K (t )
(24)
sf (k (t ))
= − (δ + g + n)
k (t )

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The Steady-State in Transformed Variables

- This equation possess a steady state, i.e. a value for which k̇ (t ) = 0, for

sf (k (t )) = (δ + g + n)k (t ) (25)
| {z } | {z }
savings break-even investment

- The steady-state effective capital-labour ratio is thus given by

f (k ? ) δ+g+n
?
= (26)
k s
- Total savings are used for replenishing the capital stock because of depreciation at rate δ,
Harrod-neutral technological progress at rate g, and population growth at rate n (which
reduces capital per worker)
- New replenishment of effective capital-labour requires investments to be equal to
( δ + g + n )k

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Actual and Break-Even Investment

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The Phase Diagram

- A unique positive stable steady

state exists, k ? > 0

- k̇ > 0 ∀k < k ? and

k̇ < 0 ∀k > k ?

- The steady state in k = 0 is of

little interest

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Steady-State and Balanced Growth Path

- The steady state in k ? corresponds to a balanced growth path in the underlying

aggregate variables
- K (t ) = A(t )L(t )k ? i.e. K (t ) grows at rate g + n
- Y (t ) exhibits CRTS in K (t ) and A(t )L(t ): both factors grow at g + n and so does Y (t )
- C (t ) = (1 − s )Y (t ) grows at g + n
- K (t )/Y (t ) constant
- K (t )/L(t ) and Y (t )/L(t ) grows at g
- The interest rate on savings, r (t ) = f 0 (k ? ) − δ, is constant
- The wage rate, ω (t ) = A(t ) [f (k ? ) − k ? f 0 (k ? )], grows at g
- Consistent with Kaldor facts
- Unfortunately, g is exogenous

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Comparative Dynamics

- How does the economy reacts to a shock i.e. to a change in its parameters?
- We are interested in the entire path of adjustment of the economy following the shock or
changing parameter
- Comparative statics: effect of parameter change on steady state
- Comparative dynamics: adjustment towards the new balanced growth path
- For example, assume that the economy is on the balanced growth path when there is
a permanent increase in s

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A Change in the Saving Rate I

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A Change in the Saving Rate II

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A Change in the Saving Rate III

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 The Solow Model and the Data

References: Acemoglu (2008, Chapter 3), Barro and Sala-I-Martin (1995, Chapters 10-12),
Romer (2019, Chapter 1.7, 4.6)

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The Solow Model and the Data

- We look at how the Solow model can be used to interpret both economic growth over
time and cross-country output differences
- The focus is still on proximate causes, like investments, capital accumulation, technology
and capital differences...
- We will discuss
- The concepts of conditional and unconditional convergence
- The growth accounting framework
- Cross-country output differences

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Speed of Convergence I

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Speed of Convergence I

- Remember that the law of motion of capital in intensive form is

k̇ (t ) sf (k (t ))
= − (δ + g + n)
k (t ) k (t )
- The left-hand side is the growth rate of k
- How fast k grows depend on the distance between the two terms on the right-hand side

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Speed of Convergence I

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Speed of Convergence II

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Speed of Convergence III

- There is conditional convergence

- The growth rate of an economy is positively related to the distance between this
economy’s level of income and its own steady state
- With equal parameters, all countries eventually converge towards the same steady
state
- In this case, the Solow model predicts absolute convergence i.e. that poor economies
should grow faster than rich economies

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Speed of Convergence IV

- To test the absolute convergence hypothesis with data, consider the following
regression
gi;t,t −1 = β ln yi;t −1 + ei;t (27)

- gi ;t ,t −1 is the annual growth rate between dates t − 1 and t in country i

- yi ;t −1 is output per worker (or income per capita) at date t − 1 in country i

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Speed of Convergence V

Figure: Own elaboration with data from the Penn World Tables

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Speed of Convergence VI

- The unconditional convergence is not supported by the data at the world-wide level
- β is approximately 0
- It requires the income gap between any two countries to decline, irrespective of what
types of technological opportunities, investment behaviour, policies and institutions
these countries have
- If countries do differ, the Solow model would not predict that they should converge in
income levels

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Speed of Convergence IV

- To test the conditional convergence hypothesis with data, consider a typical Barro
growth regression
0
gi;t,t −1 = β ln yi;t −1 + X i;t −1 α + ei;t (28)

- X i ;t −1 is a vector of variables that the regression is conditioning on with coefficient

vector α
- The covariates are potential determinants of steady state income and/or growth

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Speed of Convergence VII

Figure: Own elaboration with data from the Penn World Tables

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Speed of Convergence VIII

- There is a strong negative relationship between GDP per worker (in natural logs) in
1960 and the annual growth rate between 1960 and 2017 among the OECD
countries
- They are relatively homogeneous, with much more similar institutions, policies and initial
conditions than the entire world
- There might be a type of conditional convergence
- We need to control for certain country characteristics potentially affecting economic
growth
- This is what the vector X t −1 captures

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Speed of Convergence IX

Figure: Convergence across US States (Barro and Sala-I-Martin, 1995, 11.2)

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Speed of Convergence X

Figure: Convergence across Japanese prefectures (Barro and Sala-I-Martin, 1995, 11.5)

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Growth Accounting I

- Solow’s (1957) growth accounting framework provides a tool for evaluating the
contributions of different sources to economic growth
- We focus on the proximate causes
- It uses the Solow model to interpret both growth over time and cross-country output (or
income) differences

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Growth Accounting II

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Growth Accounting II

- Start with the production function Y = F (K (t ), A(t )L(t )), take derivatives with
respect to time, and divide throughout by Y (t )

Ẏ (t ) K (t ) ∂Y (t ) K̇ (t ) L(t ) ∂Y (t ) L̇(t ) A(t ) ∂Y (t ) Ȧ(t )

= + +
Y (t ) Y (t ) ∂K (t ) K (t ) Y (t ) ∂L(t ) L(t ) Y (t ) ∂A(t ) A(t ) (29)
| {z } | {z } | {z }
αK (t ) αL (t ) x (t )

- αK (t ) and αL (t ) are, respectively, the elasticity of output with respect to capital and
labour at time t (also known as factor shares)
- x (t ) is the contribution of technology
- The growth rate of GDP is a weighted average of the growth rates of the three inputs

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Growth Accounting III

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Growth Accounting III

- Using the fact that αK (t ) + αL (t ) = 1

 
Ẏ (t ) L̇(t ) K̇ (t ) L̇(t )
− = αK (t ) − + x (t ) (30)
Y (t ) L(t ) K (t ) L(t )

- The growth rates of Y , K , and L can be measured (not without difficulty), as can the
capital share
- x (t ) is then a residual capturing all sources of growth other than the contribution of
capital accumulation via its private return. It is known as Solow residual or Total Factor
Productivity (TFP) growth

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Growth Accounting IV

- Solow (1957) developed this framework and applied it to US data

- How much of the growth of the US economy can be attributed to increased labour and
capital inputs?
- How much of it is due to “technological progress”?
- A large part of the growth was due to technological progress

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Growth Accounting V

Figure: Extract from Barro and Sala-I-Martin (1995, Table 10.1)

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Growth Accounting VI

Figure: Extract from Barro and Sala-I-Martin (1995, Table 10.1)

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Growth Accounting VII

Figure: Extract from Barro and Sala-I-Martin (1995, Table 10.1)

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Income Differences I

- The Solow model identifies two explanations for the differences in output per worker
(among different countries or over time)
- Differences in capital per worker i.e. K /L
- Differences in effectiveness of labour (technology) i.e. A

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Income Differences II

- A quantitative analysis shows that K /L cannot account for the difference

- Consider two countries i = {poor , rich} with production function Yi = Kiα (ALi )1−α
 α
Yrich /Lrich Krich /Lrich
= (31)
Ypoor /Lpoor Kpoor /Lpoor

- Output per worker in the major industrialized countries today is approximately 10

times larger than it was 100 years ago, and 10 times larger than it is in poor countries
today
- If α ≈ 1/3, we need differences in K /L of the order of 1,000
- Even if α ≈ 1/2, we need differences in K /L of a factor of 100

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Income Differences III

- There is no evidence of such differences in capital stocks

- The capital stock per worker in industrialized countries is roughly 10 times larger than it
was 100 years ago
- Capital per worker is “only” about 20 to 30 times larger in industrialised countries than in
poor countries
- Differences in capital per worker are far smaller than those needed to account for the
differences in output per worker

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Income Differences IV

- With a narrow definition of capital, differences in K /L cannot explain differences in

Y /L
- We must allow for significant externalities on K
- Or else expand the definition of capital to include other forms, e.g. human capital
- Differences in A could explain differences in Y /L without requiring large and
unrealistic differences in capital
- But the Solow model takes g as exogenous
- The model does not even really identify what “the effectiveness of labour” is
- Instead, we need to explain what A is, how it is determined, and why it differs across
countries

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Conclusions

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The Solow Model: Recap

- A simple and tractable general equilibrium framework

- An important role is played by capital accumulation and technological progress
- There is no households’ optimization
- The Solow model generates per capita output growth
- But everything is driven by exogenous technological progress
- Even the rate of capital accumulation is exogenous, being driven by the saving rate, the
depreciation rate, and the rate of population growth
- We need to open these black boxes!

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Bibliography I

Acemoglu, D. (2008), Introduction to Modern Economic Growth, Princeton University Press, Princeton.
Barro, R., and X. Sala-I-Martin. (1995), Economic Growth, McGraw Hill, New York.
Kaldor, N. (1957), A model of economic growth, The Economic Journal 67, 591 – 624.
Romer, D. (2019), Advanced Macroeconomics, McGraw Hill, New York.
Solow, R. M. (1957), Technical change and the aggregate production function, Review of Economics and
Statistics 39, 312 – 320.