Solow Model

Question 1

What are the main two equations?

Answer 1

1) Production Function
2) Law of motion of capital (LOMOK)

Question 2

What is MPK equal to?

Answer 2

r

Question 3

What is MPL equal to?

Answer 3

w

Question 4

What is significant about profit in our production function?

Answer 4

Profits are zero

Question 5

What does profit=0 imply about the market?

Answer 5

Perfectly competitive market with free entry and exit

Question 6

What is the profit equation in our model?

Answer 6

Profit = production function (Y) - rK-wL

Question 7

Explain what is meant by capital per worker having diminishing marginal output?

Answer 7

If capital per worker increases, output per worker will increase but the size of this increase falls as k increases

Question 8

What is the growth rate of labour?

Answer 8

n

Question 9

What happens to capital and output per worker if savings increase?

Answer 9

k and y are positively correlated with s.
An inc. in savings leads to an increase in k and y.
Output per worker will grow until it reaches its new steady state

Question 10

According to the basic solow model what is the reason for different growth rates across countries?

Answer 10

It predicts that the further away a country is from steady state, the faster it grows!
This can be seen from equation of growth rate of k

Question 11

What is the main failure of the basic solow model?

Answer 11

Fails to generate sustained economic growth
I.e Doesn’t show growth in steady state only transitional growth

Question 12

What facts does solow model fit?

Answer 12

• generates differences in per capita income across countries
• generates constant capital-output ratio
• Generates constant labour/capital shares = 1-alpha and alpha
• constant interest rates

Question 13

According to basic solow model why are we so rich and they so poor?

Answer 13

We invest more and/or have lower population growth