Question 1

Cobb-Douglas
Y= AK^aL ^(1-a) where A> 0 is the level of the technology and a is a constant with 0 <a« 1.
The Cobb-Douglas function can be written in intensive form as
y Aka
The change in the capital stock over time is given by equation.
If we divide both sides of this equation by L, we get
KL=s
f(k) -dk
The right-hand side contains per capita variables only, but the left-hand side does not. Hence, it
is not an ordinary differential equation that can be easily solved. In order to transform it into a
differential equation in tems of k, we can take the derivative of k = K/L with respect to time to
et
k' E d(K/L) dt = K /L- nk where n =Ll'L. fwe substitute this result into the expression for K
L, we can rearrange tems to get

k' s f(k) -

(n + 8) k

The steady-state capital-labor ratio is determined from equation

as k* = [s A/(n + 8)] 1/(1-a).
Output at the steady state is

y* A1/(1-a) [s/(n +ö)}al(1-a)

Note that, as we saw graphically fora more general production function f (k), k* rises with the
saving rate s and the level of technology A, and falls with the rate of population growth n and the
depreciation rate .
The steady-state level of output per capita is given by y* = A1/(1-a) [s/(n +)) a/(1-a) Thus y
is a posltive function of s and A, and a negative function of n and Q. Along the transition, the
growth rate of k is given from equation by k'/k = s Ak-(1-a) - (n +ö) (1.28) If k{0) < k*, then k'/k

in equation is positive. This growth rate declines as k rises and approaches 0 as k approaches
k*. Since equation implies y'ly = a -(k/k), the behavior of yly mimics that of k'k. In particular,

the lower y(0), the higher yly.

Note that, as we saw graphically for a more general production function f(k), k* rises with the
saving rate s and the level of technology A, and falls with the rate of population growth n and the
depreciation rate . The steady-state level of output per capita is given by
y* =A1/(1-a) [s/(n +ö)]/(1-a)
We can see that increasing s increases economy but we cant do that forever since s have have
bound.Max value is 1,There for we can't increase it further ,it leads to a steady state in long
term.Therefore we cant get growth forever.
 QUESTION-2
The Solow-Swan model with Labor-Augmenting Technological progress

Suppose T() grows at a constant rate x.

Condition for change in capital stock is

Ks. FTK, L. TON -

öK --1
Dividing both sides by L

Ks. F. T] (8 + n)k2
-

Divide both sides by Kto get

kIks. Fh. TU)Vk -

(6+ n) --3

Let us now compute the growth rate of k in the steady-state.

W e k n o w t h a t i n s t e a d y - s t a t e g r o w t h r a t e (K/A) " is constant. Because s, n and d are constants

In equation 3 we can see that the average product of capital F{k, TU)Vk must also be a constant
at the steady-state. Because of CRS, avg. product equals F[1, TUVA] and is constant only if T()
and k g r o w a t t h e s a m e r a t e , i.e. (kIk) " = x.

Output per capita is given by

y= F{k, TON =k. F{1. TOVA]

TOJk is constant, k grows at the rate x, thus output per woker y also grows at the rate x. Since
C(1-s).y, the steady-state growth rate of c also equals x.
Lets see the transitional dynamics of the model with technical progress,

let us rewrite the system in terms of variables that remain constant in the steadystate.
Efective amount of laboris L L. To).
Capital per unit of effective labor is F=k TU) = KI|L. TON
Output per unit of effective labor is y'= YNL. TV) = F(£, 1)=f(R)
Using intensive forms and using the condition that A() grows at the rate x, the dynamic equation
for Kcan be written as

kTR =s. AR) R - (r *n + ) - 4

The term (r *n+ð) is now the efective depreciation rate for k.

This means, if saving rate is zero, kwould decline partly due to the depreciation of K at rate
and partly due to the rate of growth of C'i.e. (n+X). Steady-state growth rate of f is zero. The
steady-state value k satisfies the condition

. R) (r *n+ 6). R
=
-5

At steady-state, k, , ê are const.

k. y, c grow at the exogenous rate of technological progress.
K, Y, C grow at the rate ntx.

QUESTION-3

In Mid1980s, dissatisfaction with standard neo-classical growth model, since it could not
convincingly determine factors behind long run growth. In the neo-classical framework, without
technical progress, economy converges to a steady state with zero per capita growth. No long
run per capita growth due to diminishing retums to capital.
1. One way, economy could escape from diminishing returns in the long run was to
incorporate human capital into the model.
2. Another way out was to explain technical progress within the model of growth (to make
technical progress endogenous)
Focus was on the generation of new ideas to get rid of long run diminishing returns. However,
nature of ideas that underline technology was non-trivial.

Best example of a simple production function without diminishing retums is the akmodel

The AK Model
returns to capital. The simplest form of a production function which ensures absence of
diminishing returns to capital is the AK function, given by

Y AK -1

where A is a positive constant that reflects the level of technology. The idea behind no
diminishing returns becomes more plausible if we think of K in a broad sense to include human
capital. Per capita output is given by y = Ak which implies that average and marginal products to
capital are fixed at A>0.

Substitutingf(k/k=A in equation 1, we get

kIk'= sA- (n + 6)

In order to establish that per capita growth can take place without technical progress, we
assume x=0.

Since the two schedules are parallel, k 'is a constant and, in particular, independent of k. k
always grows at the steady state rate ( kk°) = sA- (n*Q).

Since y=Ak, yly' = klk "at every point in time. Also since c=(1-s)y, cde'= kIk also applies. Thus all

per capita variables grow at the same constant rate given by

SA-(n+õ) -2

An economy described by AK technology can display long run +ve per capita growth without

any technical progress. The long run per capita growth rate, shown in equation 2, depends on
the behavioral parameters of the model. Unlike the neoclassical model, a higher saving rate
leads to a higher rate of long run per capita growth. If the level of technology A improves once
and for all, or if elimination of Govt. distortion effectively raises A, then the long run growth rate
is higher. Changes in rates of depreciation and population growth rate also have permanent
effects on the per capita growth rate. Unlike the neo-classical model, the AK formulation does
not predict absolute or conditional convergence, i.e. a( y ly') ay) = 0 for all y.