The Solow Growth Model (Part Three)

The augmented model that includes population growth and technological progress.

Model Background

As mentioned in parts I and II, the Solow growth

model allows us a dynamic view of how savings affects the economy over time. We learned about the steady state level of capital and how a golden rule steady state level of capital can be achieved by setting the savings rate to maximize consumption per worker. We now augment the model to see the effects of population growth and technological progress.

Steady State Equilibrium

By expanding our model to include population growth our
model more closely resembles the sustained economic growth observable in much of the real world.

To see how population growth affects the steady state we need

to know how it affects the accumulation of capital per worker. When we add population growth (n) to our model the change in capital stock per worker becomes k = i (+n)k

As we can see population growth will have a negative effect on

capital stock accumulation. We can think of (+n)k as breakeven investment or the amount of investment necessary to keep capital stock per worker constant.

Our analysis proceeds as in the previous presentations. To see

the impact of investment, depreciation, and population growth on capital we use the (change in capital) formula from above, k = i (+n)k substituting for (i) gives us, k = s*f(k) (+n)k

Steady State Equilibrium with population growth

At the point where both
(k) and (y) are constant it Investment must be the case that, Break-even Investment k = s*f(k) (+n)k = 0 or, s*f(k) = (+n)k this occurs at our s*f(k*)=(+n)k* equilibrium point k*.
Like depreciation, population growth is one reason why the capital stock per worker shrinks.
Break-even investment
(+n)k

s*f(k)
Investment

k*

At k* break-even investment equals investment.

The impact of population growth

Suppose population growth
An increase in n
Investment Break-even Investment
(+n2)k

changes from n1 to n2. This shifts the line representing population growth and depreciation upward. At the new steady state k2* capital per worker and output per worker are lower The model predicts that economies with higher rates of population growth will have lower levels of capital per worker and lower levels of income.

(+n1)k

s*f(k)

k2*

k1*

reduces k*

The efficiency of labour

We rewrite our production function as

Y=F(K,L*E) where E is the efficiency of labour. L*E is a measure of the number of effective workers. The growth of labour efficiency is g.

Our production function y=f(k) becomes output

per effective worker since y=Y/(L*E) and k=K/(L*E)

With this augmentation k is needed to replace

depreciating capital, nk is needed to provide capital to new workers, and gk is needed to provide capital for the new effective workers created by technological progress.

Steady State Equilibrium with population growth and technological progress

At the point where both
(k) and (y) are constant it must be the case that, k = s*f(k) (+n+g)k = 0 or, s*f(k) = (+n)k this occurs at our equilibrium point k*.
Like depreciation and population growth, the labour augmenting technological progress rate causes the capital stock per worker to shrink. Investment Break-even Investment Break-even investment
(+n+g)k

s*f(k*)=(+n)k*

s*f(k)
Investment

At k* break-even investment equals investment.

k*

The impact of technological progress

Suppose the worker
efficiency growth rate changes from g1 to g2.
An increase in g Investment Break-even Investment

This shifts the line

representing population growth, depreciation, and worker efficiency growth upward.

(+n+g2)k (+n+g )k 1

At the new steady state k2* The model predicts that

s*f(k)

capital per worker and output per worker are lower.

economies with higher rates of worker efficiency growth will have lower levels of capital per worker and lower levels of income.

k2*

k1*

reduces k*

Effects of technological progress on the golden rule

With technological progress the golden rule level of capital is
defined as the steady state that maximizes consumption per effective worker. Following our previous analysis steady state consumption per worker is c* = f(k*) ( + n + g)k*

To maximize this
MPK = + n + g or MPK = n + g

That is, at the Golden Rule level of capital, the net marginal

product of capital MPK , equals the rate of growth of total output, n+g.

Steady State Growth Rates in the Solow Model with Technological Progress
Variable Capital per effective worker Output per effective worker Output per worker Symbol k=K/(E*L) Steady-State Growth Rate 0

y=Y/(E*L)=f(k) 0

Y/L=y*E

Total output

Y=y(E*L)

n+g

Conclusion
In this section we added changes in two exogenous
variables (population and technological growth) to the Solow growth model. We saw that in steady state output per effective worker remains constant, output per worker depends only on technological growth, and that Total output depends on population and technological growth.