L14 - The Neo-Classical Model of Growth (Solow-Swan Model)

Question 1

What was concluded on growth in 1952?

Answer 1

Moses Abramowitz concluded little progress made since classical period

Question 2

Why did progress drastically in the post war years?

Answer 2

• the theoretical stimulus of Keynesian economics
• the western world embarked on a period of sustained growth
• economists increased knowledge of mathematics

Question 3

What is the National Accounting Definitions?

Answer 3

 Total Output (Q) consists of consumption goods (C) and capital goods (I) so: Q = C + I

 National Income (Y) earned from productive activity is either spent on consumption goods (C) or saved (S) so: Y = C + I

In equilibrium Y=Q and thus S=I

Question 4

What is the Production Function?

Answer 4

Y=F(K,N)

Y is output, K is stock of capital and N is supply of labour

Question 5

What does the Production Function define?

Answer 5

The technology that translate inputs into outputs

Question 6

What is the Constant Returns to Scale denoted as?

Answer 6

If all inputs are doubled output doubles

zY=F(zK, zN)

Where:
Z can be any positive number
i.e K and N are both increased by 5% z=1.05 and Y also rises by 5%

If z =1/N then the production function becomes: Y/N=F(K/N, 1) This says that output per worker increases as capital per worker increases, which can be written more easily as y=f(k)

Question 7

What does the Neoclassical Model focus on?

Answer 7

Focus on the role of Capital specifically diminishing marginal product of capital

Question 8

What is the MPK (Marginal Capital of Capital)?

Answer 8

As more capital is employed for given labour force MPK eventually decline

Production function is non-linear and becomes flatter as more of the variable input in added

(SEE DIAGRAM)

Question 9

What is Savings denoted as?

Answer 9

S= sY

Where:
-s is the average (and marginal) propensity to save and 0

Question 10

What is Savings per Capita denoted as?

Answer 10

S/N=s(Y/N)= sy = sf(k)

Says that savings per worker will be fixed proportion of output per worker

Question 11

What is Investment denoted as?

Answer 11

I= ∆K+dK

Where:
∆K is new investment
dK is depreciation

Question 12

What are the 2 factors of considering how much investment is needed to keep K/N constant?

Answer 12

• Rate of Depreciation (d)
• Rate of Growth of the
  Labour (n)
  (LINKING TO MPK)

i.e.
 If capital depreciates at rate d per period then investment per head must be d x k to stop the K/N from falling

 If labour grows at rate n per period, then an additional investment of n x k will be needed to keep K/N constant

Question 13

What is the required investment needed to keep K/N (Capital/Labour Ratio) constant

Answer 13

(d+n)K

Question 14

What is the Long-Run Equilibrium condition for the required investment needed to keep K/N constant?

Answer 14

Δk= i – (d+n)k = 0

Question 15

What is the equilibrium growth relation?

Answer 15

Sf(k)=(d+n)K

Where:
Sf is savings function of ….

Question 16

What does the Equilibrium growth relation state?

Answer 16

Where savings and investment are equal. It says that output, capital and labour all grow at rate n as illustrated below.

Done since in equilibrium S=I

(See diagram)

Question 17

What shifts the equilibrium growth relation?

Answer 17

• Rise in savings rate
• Technical progress: improvement in knowledge that enables a higher output to be produced from existing resources

(See Diagram)

Question 18

What is the average labour productivity?

Answer 18

Y/N

Question 19

What is growth dependant on Neo-Classical model?

Answer 19

• On technical progress – which raises the productivity
• A rise in the savings rate will only lead to a temporary rise in the growth rate as the K/N ratio rises to the new equilibrium – where production is more capital intensive. Once this level is reached the economy grows at rate n, as before
• The model suggests convergence in Y/N over time with poor countries (or regions) growing faster than rich countries (or regions)

Question 20

What does △Y/Y = △A/A + (1-α) △N/N say?

Answer 20

Where: α is capital share, (1-α) is labour’s share.

This says that the growth of the economy depends upon:

• the rate of technical progress
• the rate of growth of the capital stock weighted by the share of capital in income
• the rate of growth of the labour force weighted by the share of labour in total income

Question 21

What is the Total Factor Productivity?

Answer 21

△A/A = △Y/Y - α△K/K - (1-α)△N/N

Where:
-ΔA/A as total factor productivity

All growth not accounted for by labour and capital, such as entrepreneurship, or the legal environment