Endogenous Growth Model

The new growth models emerging after 1986 depart from the Solow model in three
main ways. One group of models generates continuous growth by abandoning the
assumption of diminishing returns to capital accumulation. To achieve this, Paul Romer
(1986) introduced positive externalities from capital accumulation so that the creation of
economy-wide knowledge emerges as a by-product of the investment activity of individual
firms, a case of ‗learning by investing‘ (Barro and Sala-i-Martin, 2003). A second approach
models the accumulation of knowledge as the outcome of purposeful acts by entrepreneurs
seeking to maximize private profits; that is, technological progress is endogenized (P. Romer,
1990). A third class of model claims that the role of capital is much more important than is
suggested by the α term in the conventional Cobb–Douglas production function. In their
‗augmented‘ Solow model, Mankiw et al. (1992) broaden the concept of capital to include
‗human capital‘. The first two classes of model constitute the core of endogenous growth
theory whereas the Mankiw, Romer and Weil (MRW) model constitutes what Klenow and
Rodriguez-Clare (1997a, 1997b) call a ‗neoclassical revival‘. The central proposition of
endogenous growth theory is that broad capital accumulation (physical and human capital)
does not experience diminishing returns. The growth process is driven by the accumulation of
broad capital together with the production of new knowledge created through research and
development.
The new growth theory provides a theoretical framework for analyzing persistent
growth of output that is determined within the system governing the production process. In
the new growth theories, there exist technological spillovers, externalities and increasing
returns to scale. They do not expect convergence, rather they accept the fact that
disparities among countries can persist or even enlarge. They emphasize on the
importance of investments in human capital and potential gains from technology
improvements – inventions and innovations. The theories of endogenous growth can be
broadly divided into main parts
1. Where growth is driven by Research and Development (R&D) and
2. Where growth is driven by Human Capital Accumulation.

The models so far do not provide satisfying answers to the central questions about
economic growth. The models‘ principal result is a negative one: if capital‘s earnings reflect
its contribution to output, then capital accumulation does not account for a large part of either
long-run growth or cross-country income differences. And the only determinant of income in
the models other than capital is a mystery variable, the ―effectiveness of labour‖ (A), whose
exact meaning is not specified and whose behaviour is taken as exogenous. During the mid-
1980s several economists, most notably Paul Romer (1986, 1987b) and Robert Lucas (1988),
sought to construct alternative models of growth where the long-run growth of income per
capita depends on ‗investment‘ decisions rather than unexplained technological progress. The
key to endogenous steady state growth is that there should be constant returns to broad capital
accumulation‘. Hence in order to construct a simple theory of endogenous growth, the long-
run tendency for capital to run into diminishing returns needs to be modified to account for
the extraordinary and continuous increases in observed per capita incomes across the world‘s
economies.

Research & Development (R&D) based models originate from the work of Romer
(1990), and Grossman and Helpman (1991). In all these models economic growth is the result
of technological change that comes from purposive R&D activities by firms. Patents and
blueprints are non-rival goods that can be accumulated without bounds and so the
diminishing returns to capital accumulation can be avoided and growth continues.

Endogenous Growth Model

To model the accumulation of knowledge, we need to introduce a separate sector of
the economy where new ideas are developed. We then need to model both how resources are
divided between the sector where conventional output is produced and this new research and
development (or R&D) sector, and how inputs into R&D produce new ideas. The model is a
simplified version of the models of R&D and growth developed by P. Romer (1990),
Grossman and Helpman (1991a), and Aghion and Howitt (1992). The model involves four
variables: labour (L), capital (K), technology (A), and output (Y). The model is set in
continuous time. There are two sectors, a goods-producing sector where output is produced
and an R&D sector where additions to the stock of knowledge are made. Fraction aL of the
labour force is used in the R&D sector and fraction 1−aL in the goods-producing sector.
Similarly, fraction aK of the capital stock is used in R&D and the rest (1-ak) in goods
production. Both aL and aK are exogenous and constant. Because the use of an idea or a piece
of knowledge in one place does not prevent it from being used elsewhere, both sectors use the
full stock of knowledge, A.
 The quantity of output produced at time t is thus

𝑌 𝑡 = [ 1 − 𝑎 𝑘 𝐾 𝑡 ]𝛼 𝐴 𝑡 1 − 𝑎 𝐿 𝐿 𝑡 1− 𝛼
, 0<α<1

This equation implies constant returns to capital and labour: with a given technology,
doubling the inputs doubles the amount that can be produced. The production of new ideas
depends on the quantities of capital and labour engaged in research and on the level of
technology. Given the assumption of generalized Cobb–Douglas production, we therefore
write

𝐴(𝑡) = 𝐵 𝑎𝑘 𝐾 𝑡 𝛽 𝑎𝐿 𝐿 𝑡 𝛾 𝐴(𝑡)𝜃 , B > 0, 𝛽, 𝛾 ≥ 0

Where B is a shift parameter.

The production function for knowledge is not assumed to have constant returns to
scale to capital and labour. In the case of knowledge production, exactly replicating what the
existing inputs were doing would cause the same set of discoveries to be made twice, thereby
leaving ˙ A unchanged. Thus it is possible that there are diminishing returns in R&D. At the
same time, interactions among researchers, fixed setup costs, and so on may be important
enough in R&D that doubling capital and labour more than doubles output. We therefore also
allow for the possibility of increasing returns. The parameter θ reflects the effect of the
existing stock of knowledge on the success of R&D. This effect can operate in either
direction. On the one hand, past discoveries may provide ideas and tools that make future
discoveries easier. In this case, θ is positive. On the other hand, the easiest discoveries may
be made first. In this case, it is harder to make new discoveries when the stock of knowledge
is greater, and so θ is negative. Because of these conflicting effects, no restriction is placed
on θ.
It is assumed that the saving rate is exogenous and constant. In addition, depreciation
is set to zero for simplicity. Thus,

𝐾(𝑡) = 𝑠 𝑌(𝑡)

Population growth is also treated as exogenous and constant. This implies

 𝐿 (𝑡)= nL(t ), n ≥ 0

Finally, the initial levels of A, K, and L are given and strictly positive. This completes
the description of the model. Because the model has two state variables whose behaviour is
endogenous, K and A, it is more complicated to analyze than the Solow model. We therefore
begin by considering the model without capital; that is, we set α and β to zero. This case
shows most of the model‘s central messages. We then turn to the general case.

The Model without Capital

The Dynamics of Knowledge Accumulation
When there is no capital in the model, the production function for output becomes

1
𝑌 𝑡 = 𝐴 𝑡 1 − 𝑎𝐿 𝐿 𝑡
Y(t ) = A(t )(1 − aL)L(t )

Similarly, the production function for new knowledge is

𝐴(𝑡) = 𝐵 𝑎𝐿 𝐿 𝑡 𝛾 𝐴(𝑡)𝜃 ,
𝑨(𝒕)= B[𝑎𝐿 𝐿(𝑡)]𝛾 𝐴(𝑡)𝜃

Output per worker is proportional to A, and thus that the growth rate of output per
worker equals the growth rate of A. We therefore focus on the dynamics of A, which are
given by the above equation. This equation implies that the growth rate of A, denoted gA, is

gA(t ) ≡ 𝐴(𝑡)
𝐴(𝑡 )
𝐵[𝑎𝐿 𝐿(𝑡)]𝛾 𝐴(𝑡)𝜃
=
𝐴(𝑡)
𝛾
= B𝑎𝐿 𝐿(𝑡)𝛾 𝐴(𝑡)𝜃−1

Taking logs of both sides of the above equation,

𝛾 𝛾 𝜃−1
In 𝑔𝐴 𝑡 = 𝐼𝑛 [B𝑎𝐿 𝐿 𝑡 𝐴 𝑡 ]
= InB + 𝛾𝐼𝑛𝑎𝐿 + 𝛾𝐼𝑛𝐿 𝑡 + 𝜃 − 1 𝐼𝑛 𝐴 𝑡
Differentiating the two sides with respect to time gives us an expression for the
growth rate of gA (that is, for the growth rate of the growth rate of A):
 𝑔 𝐴 (𝑡)
= 0 + 𝛾0 + 𝛾𝑛 + 𝜃 − 1 𝑔𝐴 (𝑡)
𝑔𝐴 𝑡

𝑔𝐴 (𝑡)
= 𝛾𝑛 + 𝜃 − 1 𝑔𝐴 (𝑡)
𝑔𝐴 𝑡
Multiplying both sides of this expression by gA(t ) yields
𝑔 𝐴 (𝑡)
. 𝑔𝐴 (t) = 𝛾𝑛𝑔𝐴 (𝑡) + (𝜗 − 1)𝑔𝐴 𝑡 . 𝑔𝐴 (𝑡)
𝑔𝐴 𝑡

𝒈𝑨 (𝒕)= 𝜸𝒏𝒈𝑨 𝒕 + (𝜽 − 𝟏)[𝒈𝑨 (𝒕)]𝟐

The initial values of L and A and the parameters of the model determine the initial
value of gA. The above equation determines the subsequent behaviour of gA. To describe
further how the growth rate of A behaves (and thus to characterize the behaviour of output per
worker), let us distinguish among the cases θ <1, θ >1, and θ = 1.

Case 1: θ <1
The following figure shows the phase diagram for gA when θ is less than 1. That is, it
plots 𝑔𝐴 as a function of A. The production function for knowledge implies that gA is always
positive, the diagram considers only positive values of gA. The diagram shows that for the
case of θ less than 1, 𝑔𝐴 is positive for small positive values of gA and negative for large
values. Let 𝑔𝐴 denote the unique positive value of gA that implies that 𝑔𝐴 is zero. Now, 𝑔𝐴∗ is
defined by γ n + (θ− 1)𝑔𝐴∗ = 0. Solving this for 𝑔𝐴∗ yields

𝛾
𝑔𝐴∗ = 1− 𝜃 n.

𝑔𝐴

0 𝑔𝐴∗ 𝑔𝐴
 This analysis implies that regardless of the economy‘s initial conditions, gA converges
to 𝑔𝐴∗ . If the parameter values and the initial values of L and A imply gA (0) <𝑔𝐴∗ , for example,
𝑔𝐴∗ is positive; that is, gA is rising. It continues to rise until it reaches 𝑔𝐴∗ . Similarly, if gA(0)
>𝑔𝐴∗ , then gA falls until it reaches 𝑔𝐴∗ . Once gA reaches 𝑔𝐴∗ , both A and Y/L grow steadily at
rate 𝑔𝐴∗ .Thus the economy is on a balanced growth path.
This model is the first example of a model of endogenous growth. In this model, in
contrast to the Solow, the long-run growth rate of output per worker is determined within the
model rather than by an exogenous rate of technological progress.
The model implies that the long-run growth rate of output per worker,𝑔𝐴∗ , is an
increasing function of the rate of population growth, n. Indeed, positive population growth is
necessary for sustained growth of output per worker.
The fraction of the labour force engaged in R&D does not affect long-run growth.
This too may seem surprising: since growth is driven by technological progress and
technological progress is endogenous, it is natural to expect an increase in the fraction of the
economy‘s resources devoted to technological progress to increase long-run growth. To see
why it does not, suppose there is a permanent increase in aL starting from a situation where A
is growing at rate 𝑔𝐴∗ . aL does not enter expression for 𝑔𝐴 : 𝑔𝐴 (𝑡)= 𝛾𝑛𝑔𝐴 𝑡 +(θ − 1)[𝑔𝐴 (𝑡)]2 .
𝛾
aL does enter expression for gA: gA(t ) =B𝑎𝐿 L(t )γA(t )θ−1. The increase in aL therefore causes
an immediate increase in gA but no change in 𝑔𝐴 as a function of gA.
The increase in the growth rate of knowledge is not sustained. When gA is above 𝑔𝐴∗ ,
𝑔𝐴∗ is negative. gA therefore returns gradually to 𝑔𝐴∗ and then remains there. In other words, θ
less than 1 means that the contribution of additional knowledge to the production of new
knowledge is not strong enough to be self-sustaining.

Case 2: θ >1
The second case to consider is θ greater than 1. This corresponds to the case where
the production of new knowledge rises more than proportionally with the existing stock. We
know that 𝑔𝐴 = 𝛾𝑛𝑔𝐴 + (𝜃 − 1)𝑔𝐴2 .When θ exceeds 1, this equation implies that 𝑔𝐴 is
positive for all possible values of gA. Further, it implies that 𝑔𝐴 is increasing in gA (since gA
must be positive). The phase diagram is shown below.
 𝑔𝐴

0 gA

The implications of this case for long-run growth are very different from those of the
previous case. As the phase diagram shows, the economy exhibits ever-increasing growth
rather than convergence to a balanced growth path. In this case, knowledge is so useful in the
production of new knowledge that each marginal increase in its level results in so much more
new knowledge that the growth rate of knowledge rises rather than falls. Thus once the
accumulation of knowledge begins—which it necessarily does in the model—the economy
embarks on a path of ever-increasing growth.
The impact of an increase in the fraction of the labour force engaged in R&D is now
dramatic. An increase in aL causes an immediate increase in gA. But 𝑔𝐴 is an increasing
function of gA; thus 𝑔𝐴 rises as well. And the more rapidly gA rises, the more rapidly its
growth rate rises. Thus the increase in aL causes the growth rate of A to exceed what it would
have been otherwise by an ever-increasing amount.

Case 3: θ = 1
When θ is exactly equal to 1, existing knowledge is just productive enough in
generating new knowledge that the production of new knowledge is proportional to the stock.
In this case, expressions for gA and 𝑔𝐴 are

𝛾
𝑔𝐴 𝑡 = 𝐵𝑎𝐿 𝐿(𝑡)𝛾
𝑔𝐴 (𝑡) = 𝛾𝑛𝑔𝐴 (𝑡)
 If population growth is positive, gA is growing over time. In this case the dynamics of
the model are similar to those when θ >1. If population growth is zero, on the other hand, gA
is constant regardless of the initial situation. Thus there is no adjustment toward a balanced
growth path: no matter where it begins, the economy immediately exhibits steady growth.
The growth rates of knowledge, output, and output per worker are all equal to
𝛾
𝐵𝑎𝐿 𝐿𝛾 in this case. Thus changes in aL affect the long-run growth rate of the economy.
Since the output good in this economy has no use other than in consumption, it is
natural to think of it as being entirely consumed. Thus 1 − aL is the fraction of society‘s
resources devoted to producing goods for current consumption, and aL is the fraction devoted
to producing a good (namely, knowledge) that is useful for producing output in the future.
Thus one can think of aL as a measure of the saving rate in this economy.
With this interpretation, the case of θ =1 and n = 0 provides a simple example of a
model where the saving rate affects long-run growth.

The Importance of Returns to Scale to Produced Factors

The reason that the three cases have such different implications is that whether θ is
less than, greater than, or equal to 1 determines whether there are decreasing, increasing, or
constant returns to scale to produce factors of production. The growth of labour is exogenous,
and we have eliminated capital from the model; thus knowledge is the only produced factor.
There are constant returns to knowledge in goods production. Thus whether there are on the
whole increasing, decreasing, or constant returns to knowledge in this economy is determined
by the returns to scale to knowledge in knowledge production—that is, by θ.
To see why the returns to the produced input are critical to the behaviour of the
economy, let the economy is on some path, and suppose there is an exogenous increase in A
of 1 percent. If θ is exactly equal to 1, 𝐴grows by 1 percent as well: knowledge is just
productive enough in the production of new knowledge that the increase in A is self-
sustaining. Thus the jump in A has no effect on its growth rate. If θ exceeds 1, the 1 percent
increase in A causes more than a 1 percent increase in 𝐴. Thus in this casethe increase in A
raises the growth rate of A. Finally, if θ is less than 1, the1 percent increase in A results in an
increase of less than 1 percent in 𝐴, and so the growth rate of knowledge falls.

The Importance of Population Growth

When θ <1, the model has the surprising implication that positive population growth
is necessary for long-run growth in income per person, and that the economy‘s long-run
growth rate is increasing in population growth. The other cases have similar implications.
When θ = 1 and n = 0,long-run growth is an increasing function of the level of population.
And when θ >1 (or θ = 1 and n >0), an increase in population growth causes income per
person to be higher than it otherwise would have been by an ever-increasing amount.
To understand these results, we know that the equation for knowledge
𝛾 𝛾
accumulation:𝑔𝐴 𝑡 = B𝑎𝐿 𝐿 𝑡 𝐴(𝑡)𝜃=1 . Built into this expression is the completelynatural
idea that when there are more people to make discoveries, more discoveries are made. And
when more discoveries are made, the stock of knowledge grows faster, and so (all else equal)
output per person grows faster. In the particular case of θ = 1 and n = 0, this effect operates in
a special way: long-run growth is increasing in the level of population. When θ is greater than
1, the effect is even more powerful, as increases in the level or growth rate of population lead
to ever-rising increases in growth.
When θ is less than 1, there are decreasing returns to scale to produce factors, and so
the implication is slightly different. In this case, although knowledge may be helpful in
generating new knowledge, the generation of new knowledge rises less than proportionally
with the existing stock. Thus without something else making an increasing contribution to
knowledge production, growth would taper off. Because people contribute to knowledge
production, population growth provides that something else: positive population growth is
needed for long-run growth, and the rate of long-run growth is increasing in the rate of
population growth.
A natural interpretation of the model is that A represents knowledge that can be used
anywhere in the world. With this interpretation, the model does not imply that countries with
larger populations, or countries with greater population growth, enjoy greater income growth;
it only implies that higher worldwide population growth raises worldwide income growth.
This implication is plausible: because people are an essential input into producing
knowledge, it makes sense that, at least up to the point where resource limitations (which are
omitted from the model) become important, higher population growth is beneficial to the
growth of worldwide knowledge.
The General Case
Let us examine the model by incorporating capital and determine how this modifies
the earlier analysis.
The Dynamics of Knowledge and Capital
When the model includes capital, there are two endogenous state variables, A and K
and we focus on the dynamics of the growth rates of A and K. let us now examine the
dynamics of the growth rates of A and K. the production function is

𝑌 𝑡 = [ 1 − 𝑎 𝑘 𝐾 𝑡 ]𝛼 𝐴 𝑡 1 − 𝑎 𝐿 𝐿 𝑡 1− 𝛼
, 0<α<1

Now, let us substitute the production function equation into the equation
{𝐾(𝑡) = sY(t)}, we get

𝐾(𝑡) = 𝑠 1 − 𝑎𝐾 𝛼 ( 1 − 𝑎𝐿 )1− 𝛼 𝐾(𝑡)𝛼 𝐴(𝑡)1− 𝛼 𝐿(𝑡)1− 𝛼

𝛼
Dividing both sides by K(t ) and defining cK= 𝑠 1 − 𝑎𝐾 ( 1 − 𝑎𝐿 )1− 𝛼 gives us

𝐾(𝑡)
𝑔𝐾 𝑡 =
𝐾(𝑡)
1− 𝛼 𝛼 1− 𝛼 1− 𝛼
𝑠 1− 𝑎𝐾 𝛼 ( 1− 𝑎𝐿 ) 𝐾(𝑡) 𝐴(𝑡) 𝐿(𝑡)
=
𝐾(𝑡)

𝐶𝐾 𝐾(𝑡)𝛼 𝐴(𝑡)1−𝛼 𝐿(𝑡)1−𝛼

=
𝐾(𝑡)

𝐾 𝑡 𝛼 𝐴 𝑡 1−𝛼 𝐿 𝑡 1−𝛼
= 𝐶𝑘 [ ]
𝐾 𝑡

𝐴 𝑡 1−𝛼 𝐿 𝑡 1−𝛼
= 𝐶𝐾 [ ]
𝐾(𝑡)1 𝐾(𝑡)−𝛼

𝐴 𝑡 1−𝛼 𝐿 𝑡 1−𝛼
= 𝐶𝐾 [ ]
𝐾(𝑡)1−𝛼
 𝐴 𝑡 𝐿 𝑡 1− 𝛼
= 𝐶𝐾 [ ]
𝐾 𝑡

Taking logs of both sides, we get

𝐴 𝑡 𝐿 𝑡 1− 𝛼
In 𝑔𝐾 𝑡 = 𝐼𝑛 [𝐶𝐾 [ ] ]
𝐾 𝑡

= In𝐶𝐾 + 1 − 𝛼 𝐼𝑛𝐴 𝑡 + 1 − 𝛼 𝐼𝑛𝐿 𝑡 − 1 − 𝛼 𝐼𝑛𝐾(𝑡)

Differentiating the above equation with respect to time yields
𝑔 𝐾 (𝑡)
𝑔𝐾 𝑡
= 0 + 1 − 𝛼 𝑔𝐴 𝑡 + 1 − 𝛼 𝑛 − 1 − 𝛼 𝑔𝐾 (𝑡)

𝑔𝐾 (𝑡)
= 1 − 𝛼 [𝑔𝐴 𝑡 + 𝑛 − 𝑔𝐾 𝑡 ]
𝑔𝐾 𝑡

gK is always positive. Thus gK is rising if gA+ n − gK is positive, falling if this

expression is negative, and constant if it is zero. This information is summarized in the
following figure. In (gA, gK) space, the locus of points where gK is constant has an intercept of
n and a slope of 1. Above the locus, gK is falling; below the locus, it is rising.

gK 𝑔𝐾 = 0

(𝑔𝐾 < 0)

𝑔𝐾 > 0
n

0
gA

Similarly, dividing both sides of equation 𝐴= B(𝑎𝐾 𝐾)𝛽 (𝑎𝐿 𝐿)𝛾 𝐴𝜃 , by A yields an
expression for the growth rate of A:
𝐴(𝑡) 𝐵[𝑎𝐾 𝐾 𝑡 ]𝛽 [𝑎𝐿 𝐿(𝑡)]𝛾 𝐴(𝑡)𝜃
=
𝐴 𝑡 𝐴(𝑡)
𝛽 𝛾
= 𝐵𝑎𝐾 𝐾(𝑡)𝛽 𝑎𝐿 𝐿(𝑡)𝛾 𝐴(𝑡)𝜃−1
 𝛽 𝛾
= 𝐵𝑎𝐾 𝑎𝐿 𝐾(𝑡)𝛽 𝐿(𝑡)𝛾 𝐴(𝑡)𝜃−1
𝑔𝐴 𝑡 = 𝐶𝐴 𝐾(𝑡)𝛽 𝐿(𝑡)𝛾 𝐴(𝑡)𝜃−1

𝛽 𝛾
Where cA≡ B𝑎𝐾 𝑎𝐿 . Taking logs and differentiating with respect to time gives

𝛽 𝛾 𝜃−1
In 𝑔𝐴 𝑡 = 𝐼𝑛[𝐶𝐴 𝐾 𝑡 𝐿 𝑡 𝐴 𝑡 ]

𝑔𝐴 𝑡
= 𝐼𝑛 𝐶𝐴 + 𝛽𝐼𝑛 𝐾 𝑡 + 𝛾𝐼𝑛𝐿 𝑡 + 𝜃 − 1 𝐼𝑛 𝐴 𝑡
𝑔𝐴 𝑡

𝑔𝐴 𝑡
= 0 + 𝛽𝑔𝐾 𝑡 + 𝛾𝑛 + (𝜃 − 1)𝑔𝐴 (t)
𝑔𝐴 𝑡

𝑔𝐴 (𝑡)
= 𝛽𝑔𝐾 𝑡 + 𝛾𝑛 + 𝜃 − 1 𝑔𝐴 (𝑡)
𝑔𝐴 𝑡

Thus gA is rising if βgK+ γ n + (θ −1)gA is positive, falling if it is negative, and constant

if it is zero. This is shown below. The set of points where gA is constant has an intercept of −γ
n/β and a slope of (1 − θ)/β. Above this locus, gA is rising; and below the locus, it is falling.

gK 𝑔𝐴 = 0

(𝑔𝐴 > 0) (𝑔𝐴 < 0)

0
gA
𝛾𝑛
−
𝛽
 The production function for output exhibits constant returns to scale in the two
produced factors of production, capital and knowledge. Thus whether there are on net
increasing, decreasing, or constant returns to scale to the produced factors depends on their
returns to scale in the production function for knowledge. As that equation shows, the degree
of returns to scale to K and Ain knowledge production is β + θ: increasing both K and A by a
factor of X increases A by a factor of Xβ+θ. Thus the key determinant of the economy‘s
behaviour is now not how θ compares with 1, but how β + θ compares with 1. We will limit
our attention to the cases of β + θ <1 and of β + θ =1 with n = 0.
The remaining cases (β + θ >1 and β + θ =1 with n >0) have implications similar to
those of θ >1 in the simple model;

Case 1: β +θ <1
If β + θ is less than 1, (1 − θ)/β is greater than 1. Thus the locus of points where 𝑔𝐴 = 0
is steeper than the locus where 𝑔𝐾 = 0. The initial values of gA and gK are determined by the
parameters of the model and by the initial values of A, K, and L. Their dynamics are then as
shown in the figure.

𝑔𝐴 =0
gK 𝑔𝐾 =0

E
𝑔𝐾∗

0
𝑔𝐴∗ gA
𝛾𝑛
-𝛽
 The figure shows that regardless of where gA and gK begin, they converge to Point E in
the diagram. Both 𝑔𝐴 and 𝑔𝐾 are zero at this point. Thus the values of gA and gK at Point E,
which we denote g* A and g*K , must satisfy
𝑔𝐴∗ + 𝑛 − 𝑔𝐾∗ = 0
and
𝛽𝑔𝐾∗ + 𝛾𝑛 = 𝜃 − 1 𝑔𝐴∗ = 0
Or, 𝛽𝑔𝐴∗ + 𝛽 + 𝛾 𝑛 + 𝜃 = 1 𝑔𝐴∗ = 0
𝛽 +𝛾
Or, 𝑔𝐴∗ = 𝑛
1− 𝜃+𝛽

From above, 𝑔𝐾∗ is simply 𝑔𝐴∗ + n, and when A and K are growing at these rates, output
is growing at rate 𝑔𝐾∗ . Output perworker is therefore growing at rate 𝑔𝐴∗ . This case is similar
to the case when θ is less than 1 in the version of the model without capital. Here, as in that
case, the long-run growth rate of the economy is endogenous, and again long-run growth is
an increasing function of population growth and is zero if population growth is zero. The
fractions of the labour force and the capital stock engaged in R&D, aL and aK, do not affect
long-run growth; nor does the saving rate, s. The reason that these parameters do not affect
long-run growth is essentially the same as the reason that aL does not affect long-run growth
in the simple version of the model.
Models like this one and like the model without capital in the case of θ <1are often
referred to as semi-endogenous growth models. On the one hand, long-run growth arises
endogenously in the model. On the other, it depends only on population growth and
parameters of the knowledge production function, and is unaffected by any other parameters
of the model. Thus, growth seems only somewhat endogenous.

Case 2: β +θ = 1 and n = 0
The locus of points where 𝑔𝐾 = 0 is given by gK= gA+n, and that the locus of points
where 𝑔𝐴 = 0 is given by gK= −(γn/β) +[(1−θ)/β]gA. When β+θ is 1 and n is 0, both
expressions simplify to gK= gA. That is, in this case the two loci lie directly on top of each
other: both are given by the 45-degree line. The dynamics of the economy in this case.
 gK
𝑔𝐾 = 𝑔𝐴 = 0

450
gA

As the figure shows, regardless of where the economy begins, the dynamics of gA and
gK carry them to the 45-degree line. Once that happens, gA and gK are constant, and the
economy is on a balanced growth path. As in the case of θ =1 and n = 0 in the model without
capital, the phase diagram does not tell us what balanced growth path the economy converges
to. However, one can show that the economy has a unique balanced growth path for a given
set of parameter values, and that the economy‘s growth rate on that path is a complicated
function of the parameters. Increases in the saving rate and in the size of the population
increase this long-run growth rate Because long-run growth depends on a wide range of
parameters, models like this one, as well as the model of the previous section when θ ≥1 and
the model of this section when β + θ >1 or β + θ =1 and n >0, are known as fully endogenous
growth models.