economic essay

SESSION 5 18TH JANUARY 20

INTRODUCTION TO

ECONOMIC GROWTH

SOMASRI MUKHOPADHYAY

Basic Solow Model

Technology and Solow Model

Human Capital in Solow Model

THE NEOCLASSICAL GROWTH MODEL THE SOLOW MODEL (1956)

Inclusion of Labour as a factor of Production

Capital-Output Ration not Constant / Fixed

The Solow Model – Basic Model

Short Run Growth – Determined by Moving to a new Steady

State

Change in Capital Investment, Labour Force

and Depreciation Rate

Change in Capital Investments Result from the

Change in Savings Rate

Long Run

Growth is Achieved through Technological

Progress

Long Run Inclusion of Technology in Basic Solow Model

Solow Romer Model

Extension/ Improvement Over Harrod-Domer

Model

The World in 1950

• The annual GDP Growth of the Developed Economies Averaged around 5 per cent during 1950-1970

• There was no major recessions experienced during this period. • United Sates Emerged as a Global Power from World War II, thus

acquiring a powerful economic position. • The U.S. dollar became the world's major reserve currency. • U.S. corporations took leading positions in many industries. • Europe and Asia experienced extensive destruction and loss of life. • Europe and Japan had to spend the postwar decade in extensive

reconstruction; they became heavily dependent on official aid from the United States

• However, following reconstruction of their war-devastated economy, over time Europe and Japan was able to narrow the technological and productivity gap with the United States.

The World in 1950 Beginning of the Reconstruction of a New World Economy 1950-1970

The Neo-Classical Period Developing the Model Model

Mathematical Representation of

Some Economic Aspect Maximise Utility

Subject to Constraint for

Maximising the Utility

Demand Supply Interaction

Countries produce and consume Single Homogeneous Product

Technology is Exogenous

Models and Assumptions “All theory depends on Assumptions which are

not quite true.”

This Output as a country’s GDP

Implication No International

Trade

Technology available by firms is unaffected

by their action.

Assumptions Throughout

Some Common Choices to Make • How much to consume today and

how much to save • How much time to spend in to

accumulate skills and how much time to spend working in the labour

market

Summarise the Problems of Optimisation

Summarise the results of optimisation with Elementary Rules Individuals save a constant fraction of

their income And

Spend a constant fraction of their time accumulating skills

Inclusion of Labour as a factor of Production

Capital-Output Ration not Constant / Fixed

The Solow Model (1956)

Extension/ Improvement Over Harrod-Domer

Model

Two Equations

Production Function Y = f(K,L)

Capital Accumulation ∆K = sY-βK

The Solow Model (1956) The Two Foundation Pillars

• Y = f (K,L) – Where – Y= Output – K = Capital – L = Labour

• A Cobb-Douglass Production Function – Exhibiting Constant Returns to Scale – Y = KαL 1- α

• Where α ranges between 0 and 1

The Production Function

• Firms Maximise Profit – Max f(K,L) – (rK+wL)

• Going by Optimisation Problem – Firms will hire labour till their wage per unit is

equal to the contribution in output for an additional unit of labour employed.

– Firms will rent capital to the point where the per unit rent is equal to the contribution in output for an additional unit of capital employed.

The Production Function

Reference • Y = f (K,L)

– Where – Y= Output – K = Capital – L = Labour

• A Cobb-Douglass Production Function – Exhibiting Constant Returns to Scale

– Y = KαL 1- α • Where α ranges between 0 and 1

Some More Assumptions • Workers are paid wages – w • Capital is paid rent - r • Perfect Competition Prevails

– Firms are Price Takers

• Firms Maximise Profit – Max f(K,L) – (rK+wL)

• Going by Optimisation Problem – Firms will hire labour till their

wage per unit is equal to the contribution in output for an additional unit of labour employed.

– Firms will rent capital to the point where the per unit rent is equal to the contribution in output for an additional unit of capital employed.

The Production Function Continued

Reference • Y = f (K,L)

– Where – Y= Output – K = Capital – L = Labour

• A Cobb-Douglass Production Function – Exhibiting Constant Returns to Scale

– Y = KαL 1- α

• Where α ranges between 0 and 1

Some More Assumptions • Workers are paid wages – w • Capital is paid rent - r • Perfect Competition Prevails

– Firms are Price Takers

• Let us Derive the Mathematical Equations

Production Function How Does it Look Like y

y = Kα

k

A Typical Cobb-Douglas Production Function

• ∆K = sY - ΩK

Lets Explain the Equation for Capital Accumulation

Capital Accumulation

Solving the Solow Model