6 The Solow Growth Model Flashcards
The two things that output can be used for and the equation that links them
Output can be either consumed, or invested back into production (back into capital)
Ct + It = Yt
This is a resource constraint.
What is the capital accumulation equation?
What are the change in capital equations?
Define real interest rate
The amount a person can earn by saving one unit of output for a year, or equivalently, the amount a person must pay to borrow one unit of output for a year.
Measured in: units of output (or constant dollars rather than nominal)
How are saving and investment related?
Why is the real interest rate equal to the rental rate of capital?
- We define the real interest rate as the amount a person can earn from saving capital.
- The unit of saving gets used as the unit of investment.
- A unit of investment becomes a unit of capital.
- Therefore, the return on saving is equal to the price at which the unit of capital can be rented.
The real interest rate equals the rental price of capital that clears the capital market, which in turn is equal to the marginal product of capital.
How do we solve the Solow model?
What is the steady-state position?
When depreciation = investment, at capital level K*.
What are transition dynamics?
The transition of the economy over different levels of capital toward the steady-state level.
The further from steady-state the economy is, the faster it transitions back to steady-state.
Solving for the steady-state mathematically
What is the capital-output ratio given by the Solow model?
Why does an economy settle at a steady-state?
What does the Solow model imply about long-run economic growth?
It does not exist. The economy will just stay at the steady-state level.
Of course, we have assumed population stays constant, so this conclusion could equally spring from this.
What is the principle of transition dynamics?
The farther below its steady state (in percentage terms), the fast the economy will grow.
The farther above its steady state (in percentage terms), the slower the economy will grow.
