Solow growth model a model showing how saving, population growth, and technological progress determine the level

of and growth in the standard of living general production function equation Y=F(K,L) the Solow growth model assumes that the production function has constant returns to scale constant returns to scale is by definition zY=F(zK,ZL), for any positive number z set z=1/L in the production function Y/L=F(K/L,1) output per worker Y/L capital per worker K/L the assumption of constant returns to scale implies that the size of the economy -as measured by the number of workers- does not affect the relationship between output per worker and capital per worker y Y/L output per worker k K/L capital per worker y= f(k)=F(K,1) the slope of f shows how much extra output a worker produces when given an extra unit of capital MPK marginal product of capital, f(k+1)-f(k) the production function f exhibits diminishing marginal product of capital c consumption per worker i investment per worker with regard to demand, y= c+i y=c+i is the per-worker version of the national income accounts identity for an economy, note that it omits government purchases and net exports s the saving rate, fraction of income saved (1-s) fraction of income consumed

c= (1-s)y prove i=sy y=(1-s)y+i the rate of saving is also the fraction of output devoted to investment the two main ingredients of the Solow model are the production function and the consumption function two forces influence the capital stock investment and depreciation investment expenditure on new plant and equipment investment causes capital stock to rise depreciation the wearing out of old capital depreciation causes the capital stock to fall i= sf(k) delta (on this will be d) the certain fraction of the capital stock which wears out each year, the depreciation rate d depreciation rate depreciation rate the fraction of the capital stock which wears out each year express the impact of investment and depreciation on the capital stock delta k = i-dk delta k the change in the capital stock between one year and the next delta k= sf(k)-dk k* the capital stock at which the amount of investment equals the amount of depreciation, the steady-state level of capital steady-state level of capital the level of capital at which the capital stock and output are steady over time the steady state represents the long-run equilibrium of the economy if the saving rate is high, the economy will have a large capital stock and a high level of output in the steady state if the saving rate is low, the economy will have a

small capital stock and a low level of output in the steady state growth effect policies that alter the steady-state growth rate of income per person are said to have a growth effect level effect A higher saving rate is said to have a level effect, because only the level of income per person -not its growth rate- is influenced by the saving rate in the steady state