What Is Solow Growth Model?

Solow Growth Model refers to an exogenous neoclassical model of economic

growth representing enhanced capital accumulation, technological progress,
and increased labor used to achieve short-term equilibrium. It shows that the
economies of every nation will reach a steady state or converge at the same
level of savings, labor, depreciation, and production growth.

The Solow model is the foundation of the latest theories on economic growth.
This model has made it possible to explain the faster economic growth of
developing nations. It had also successfully predicted the fast economic growth
of China as compared to western nations and the speedier economic recovery
of war-hit Japan and Germany.

Key Takeaways

• Solow Growth Model is an exogenous neoclassical model of economic

growth representing the changes in output level due to changes in labor,
capital accumulation change, and technological progress.
• The most commonly used Solow growth model equation is Y = Af (K, L)
• A few Solow growth model assumptions are- the manufacture of a
single blended product, deduction of depreciation, variable costs,
sufficient & endless labor employment, sufficiently employed capital,
homogenous technical progress, and unchanged saving ratio.
 • Economist Robert M. Solow won the Nobel Prize for economics in 1987
for this model.

Solow Growth Model Explained

Robert Solow’s Growth Model represents the economic model that economists
use to explain the direct relationship between economic growth that capital
accumulationleads. Professor of economics, Robert. M Solow forwarded the
Solow neoclassical growth model or Solow swan economic growth model. In
1956, he did it to produce an alternative to the Keynesian Harro-Domar model
in the absence of the assumed fixed ratio in productions. Robert M. Solow
received the Economic Nobel Prize in 1987 for this pathbreaking growth model
in macroeconomics.

This neoclassical growth model assumes that the output of goods producers
produce utilizes the labor and capital at a scale of constant returns. It means
that the output produced is either stored or completely used up. Moreover,
the capital stockaccumulated during the production is determined by
subtracting the depreciation from the total accumulated savings related to the
past periods. Here, the producers assume a fixed labor supply and deem the
saving to be a fixed output ratio.

The model assumes that initially, the economy is in a position of minimal

capital stock. Hence, in every specified period, the capital stock will increase
with the help of saving until it reaches a steady state where
the depreciation equals the savings. During the path to a steady state of
capital stock, there will also be an increase in consumption per capita, leading
to the economy’s growth.

Furthermore, as soon as it achieves the steady-state, the consumption per

capita also becomes saturated. As a result, economic growth stops. Therefore,
if the economy has to witness any more growth, then the exogenous factors
have to change, like the improvement in the technology for enhancing the
quantity of output vis-a-vis the inputs for production.
Solow Growth Model Graph

Here is a Solow growth model graph to understand the concept better.

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The graph represents the output-per-effective-worker, on the Y-axis, for an

economy over a specific period. For simplicity, it assumes the absence of the
government sector, zero population growth, and constant labor productivity.

The graph represents a steady-state at the point where the line (n+d)k
intersects with the sY curve. The economy will always end up in a steady state.
Steady-state is the key to understanding the Solow model.

The depreciation curve, i.e., the straight line, is proportional to the amount of
capital. With the capital increase, depreciation also increases. Capital and labor
also observe proportional growth. Prof. Solow assumes constant returns to
scale, so real output grows at the same rate (n), and output per head of worker
remains constant.

Extra investment increases the output. So, the output per worker increases
with an increase in capital per worker. However, the production function line,
i.e., Y = f(K), shows that output per worker increases at a diminishing rate as K
(capital) increases due to the law of diminishing returns.
The saving rates (assumed fixed) are equal to actual investment, i.e., sY. So
firms multiply their investments by savings.

So one can observe that initially, Investment > Depreciation, i.e., capital grows.

In the next phase, Investment < Depreciation. It means the capital shrinks.

At the steady-state, Investment = Depreciation. At this point, all the

investment is used to maintain the depreciation.

Equation

Here is the Solow growth model equation–

For the sake of simplicity, analysts and economic researchers assume that the
economy is a closed economy without any external trade influence or
government role. The most common equation used in this growth model is-

Y = Af (K, L)

where Y= real GDP

• A = Measure of productivity
• K= Capita Share (measured in physical units or in $ value)
• L= Labor

For other equations of the Solow neoclassical growth model formula, one will
be using the following terminologies:

• Gw = Per worker GDP (Gross Domestic Product) and is also the capital’s
square root
• Kw = Per worker capital
• Rd = Depreciation rate
• Rs = Rate of saving

For isolated economy, per worker GDP, G = Cw + Iw where Cw = per worker

consumption & Iw = investment per worker

Applying the above terminologies, the major equations of the Solow growth
model steady state are:

1. Production function, Gw = function (per worker capital, K) = f(kW)

 2. Investment, I= saving rate (per worker capital, Y) = Rs (Gw)
3. Consumption, C= (1-Rs) Gw
4. Variation in capita concerning labor ratio, Vcl = Iw-d Kw
5. If the Vcl becomes zero for an economy, it has achieved the steady-state.
As a result, the per worker investment gets equal to that of the product
of the depreciation rate and per worker capital. So, Iw = Rd* Kw

Assumptions

Solow hypothesized that the constant production function could link the
outputs to labor and interchangeable capital inputs. To prove his theory, he
assumed the following for his model:

1. Manufacturing single blended product.

2. One can consider output only after capital deducting depreciation from
the net output.
3. The function of production is congruent to the first degree.
4. Production grows at a constant rate.
5. One compensates labor and capital as per the insignificant tangible
efficiency.
6. Costs and compensation are variable.
7. Labor employment is always sufficient and endless.
8. The stock of capital is also fully sufficiently employed.
9. Capital is interchangeable with labor, and vice versa is also true.
10.The technical progress is homogenous across the production of the
goods.
11.The ratio of savings is always unchanged. Savings = Investment.