TA session 3 notes: Econ 316

Briefly, an elasticities review:

The elasticity of y with respect to x is give by
yx =

y x
x y

and is interpreted as follows: a 1% increase in x corresponds to a yx % increase in y.

Why? Because the elasticity is analogous to the ratio of percentage changes:
y x

x y

yfinal yinitial
yinitial
xfinal xinitial
xinitial

% change in y
% change in x

So a 1 on the denominator means that the numerator reads % change in y = yx . Lets

do a specific example:
Y (K, AL) = K (AL)1
what is Y K ?
Y K =

K
Y K
= K 1 (AL)1
K Y
Y

Now since Y = K (AL)1 ,

K 1 (AL)1 =

Y
K

Pulling this into our expression for Y K , we have

Y K
KY
So the elasticity of output with respect to capital is .
Y K =

[Next, we go over some homework, see the solutions for these notes]
Now, well do problem 1.12(a):
One view of technological progress is that the productivity of capital goods built at
time t depends on the state of technology at t is unaffected by subsequent technological
progress. This is known as embodied technological progress. This problem asks you to
investigate its effects. To start, lets modify the basic Solow model to make technological progress capital-augmenting rather than labor-augmenting. So that a balanced
growth path exists, assume that the production function is Cobb-Douglas:
Y (t) = [A(t)K(t)] L(t)1

assume that A grows at rate : A(t)

= A(t). Show that the economy converges
to a balanced growth path [Hint: show that we can write Y /(A L) as a function of
K/(A L), where = /(1 ). Then analyze the dynamics of (K/(A L))]
1

 The production function is

Y (t) = [A(t)K(t)] L(t)1
Following the hint, we re-write variables to get new variables that will have a
steady state:
Y (t)
1
=
[A(t)K(t)] L(t)1

1
1
A(t) L(t)
A(t) L(t)
we can bring the

A(t) 1

term inside of both expressions to get:

 
1
A(t)K(t)
L(t)

A(t) 1
A(t) 1
!



A(t)1 1 K(t)
K(t)

A(t) =

L(t)
A(t) 1 L(t)

Y (t)
1
=

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

A(t) 1 L(t)

Success! We have something that looks like

y(t) = k(t)
where y(t) =

Y (t)

A(t) 1 L(t)

and k(t) =

K(t)

A(t) 1 L(t)

We now analyze

k(t)
=

h
i



K(t) A(t) L(t) K(t) A(t) A(t)L(t) + L(t)A(t)

[A(t) L(t)]2

K(t)

where = 1
and k = A(t)
L(t) . Recall that A(t)/A(t) = and L(t)/L(t) = n.
So the above simplifies to

k(t)
=

K(t)
( + n)k(t)
[A(t) L(t)]

And we know K(t)

= sY (t) K(t), so that

k(t)
= sy(t) ( + n + )k(t)
Whats the point there? That we now have a characterization of the steady
state and we know that it exists! We have the picture of actual vs. break even
investment, just as before but with slightly different numbers.