What is Solow model of economic growth? Economics Notes

The Solow Model of Growth, also known as the Solow-Swan model, is a foundational framework in macroeconomics that explains long-run economic growth by focusing on capital accumulation, labor force growth, and technological progress. Developed by Robert Solow and Trevor Swan in the 1950s, the model is a cornerstone of neoclassical growth theory and remains central to understanding how economies evolve over time23457.

Key Assumptions of the Solow Model

• Two Factors of Production: Output is produced using capital (K) and labor (L)145.

• Constant Returns to Scale: Doubling both capital and labor will double output45.

• Diminishing Marginal Productivity: Adding more of one input (capital or labor) while holding the other constant leads to smaller increases in output127.

• Constant Savings Rate (s): A fixed proportion of output is saved and invested145.

• Constant Population Growth Rate (n): The labor force grows at a constant rate145.

• Constant Depreciation Rate (δ): Capital depreciates at a fixed rate145.

• Closed Economy: No international trade or government intervention is considered1.

• Exogenous Technological Progress (A): Technological improvements occur at a constant, external rate137.

Core Components

1. Production Function

The model uses a neoclassical production function, typically:

$$$$Y=F(K,L,A)

where:

• Y = Output,
• K = Capital,
• L = Labor,
• A = Level of technology (total factor productivity)37.

2. Capital Accumulation

Capital stock evolves according to:

$$$$

where $sY_t$ is new investment (savings) and $\delta K_t$ is depreciation45.

3. Steady State

The model predicts that economies converge to a steady state where capital per worker and output per worker remain constant over time. In steady state:

$$$$

where $k^*$ is steady-state capital per worker, and $f(k)$ is output per worker as a function of capital per worker67.

4. Role of Savings and Population Growth

• Higher Savings Rate: Leads to a higher steady-state level of output and capital per worker, but not to sustained growth in per capita output13.
• Higher Population Growth: Reduces steady-state capital per worker, thus lowering steady-state output per worker47.

5. Technological Progress

When technological progress is included, output per worker can grow even in the steady state. The long-run growth rate of output per worker is determined by the rate of technological progress237.

Implications of the Solow Model

• Temporary Effects of Policy: Changes in savings or investment rates lead to higher or lower steady-state output, but only technological progress can generate sustained growth in per capita income123.
• Convergence Hypothesis: Poorer countries will tend to grow faster than richer ones, provided they have similar savings rates, population growth, and access to technology, leading to convergence in income levels over time7.
• Importance of Technology: In the long run, only technological progress can sustain increases in living standards37.

Diagrammatic Representation

A typical Solow diagram plots output per worker ($y$), savings per worker ($sy$), and break-even investment ($(n+\delta)k$ against capital per worker ($k$). The intersection determines the steady-state level of capital per worker.

Conclusion

The Solow growth model provides a clear framework for understanding the determinants of long-run economic growth. It highlights the crucial roles of capital accumulation, population growth, and especially technological progress. While increases in savings or investment can raise the level of output, only advancements in technology can sustain growth in output per capita over time1347. This model underpins much of modern growth theory and remains essential for both economic analysis and policymaking.

IGNOU sources: For further reading, refer to IGNOU’s eGyanKosh materials, especially Unit 2 and Unit 3 on the Solow Model45.

References:

1. https://mgcub.ac.in/pdf/material/202005060446103aa42a2e15.pdf
2. https://en.wikipedia.org/wiki/Solow%E2%80%93Swan_model
3. https://in.indeed.com/career-advice/career-development/solow-growth-model
4. https://www.egyankosh.ac.in/bitstream/123456789/76553/1/Unit-2.pdf
5. https://egyankosh.ac.in/handle/123456789/22897
6. https://www.ignouassignmentwala.in/explain-the-concept-of-steady-state-growth-in-the-solow-model-with-appropriate-diagram-show-that-the-golden-rule-of-phelps-is-not-a-steady-state/
7. https://testbook.com/ugc-net-economics/solow-model-of-economic-growth
8. https://www.albany.edu/~bd445/Economics_301_Intermediate_Macroeconomics_Slides_Spring_2014/Solow_Growth_Model.pdf
9. https://egyankosh.gkpad.com/page/103187?mode=full
10. https://mru.org/practice-questions/solow-model-1-%E2%80%93-introduction-practice-questions
11. https://mgcub.ac.in/pdf/material/202004060137222547175f8d.pdf
12. https://www.youtube.com/watch?v=a9eYBjQhaWE
13. https://prepp.in/news/e-492-solow-swan-growth-model-indian-economy-notes
14. https://corporatefinanceinstitute.com/resources/economics/solow-growth-model/
15. https://www.youtube.com/watch?v=NlGg99E_DiQ
16. https://webservices.ignou.ac.in/assignments/Master-Degree/MADVS/MADVS%20July%202024-%20Jan%2025%20(1).pdf
17. https://www.youtube.com/watch?v=r8usnKv1sm4
18. https://www.applebacademy.com/solow-model/