Econ 101 Macroeconomics1

1st Semester, AY 2014-2015

Solow Growth Model

1

Aggregate Variables
Y =C +I
Y
C +S

=) S = I:

Y = F (K; L) ;
where F ( ) is the standard neoclassical production function, which exhibits constant returns to scale (CRTS),
FK ; FL > 0 and FKK ; FLL < 0:
Gross investment is given by
I = K + K;
dK
2 (0; 1) is the constant depreciation rate of capital.
where K
dt and
There is no unemployment in this economy, so that L denotes both population and total labor supply.
Population grows at a constant rate; n > 0; i.e.,

L
= n > 0:
L

Per-capita Variables

In per capita terms,

C
I
Y
=
+ =) y = c + i
L
L
L
C
S
S
Y
=
+ =) y = c + :
L
L
L
L
Constant returns to scale implies that

zY
Y
L

= F (zK; zL) ; z =
= F

K
;1
L

1
L

=) y = f (k) :

Per capita investment is given by

I
K
K
K
=
+
=) i =
+ k:
L
L
L
L
To derive K=L; we start with
1 S.

Daway

(1)

K
k
K
=) =
L
k
K

k
k
k

K
K

K
k
K

K
L

K
L

L
L

n
nk
nk

= k + nk:

(2)

Plugging in (2) into (1) and rearranging yields

k = fig

(n + ) k:

k T 0 () i T (n + ) k:
The term (n + ) k is called the break-even level of investment. When i = (n + )k; per-capita investment
is just enough (or per capita capital is growing just enough) to equip the new entrants into the labor market
and to replace capital that has depreciated.

= fy

= ff (k)
k=

cg

(n + ) k
cg

S
L

(n + ) k

(n + ) k:

(3)

(4)

Assuming that savings are a constant fraction of output, denoted by s 2 (0; 1) ; i.e.,
S
S
L
S
L

= sY
Y
S
= s =) = sy
L
L
= sf (k) :

(5)

Plugging in (5) into (4) yields

k = sf (k)

(n + ) k;

which is the fundamental neoclassical growth equation.

k = 0 =) sf (k ) = (n + ) k :
In graphical terms,

(6)

What happens when s increases? What about if either n or

increases?