term 2 lecture 1 : the basic solow model Flashcards
what is the framework for the market for output?
economic agents in the model are households and firms
assume that all households are identical and all firms are identical
it has a 2 sector economy so government spending and net exports is equal to 0 so ouput is equal to consumption plus investment with investment transforming output into physical capital
output is homogenous
the price of the output market is normalised to one
input prices are measured in units of output
what is the framework for the market for capital services?
physical capital stock is owned by households and lent out to firms
the price in the market for capital services is a real rental rate R
the physical capital is subject to depreciation at a rate z
what is the dynamics of capital per worker given by>
k^.=sy-(g+n)k where sy is gross investment and (g+n)k is the break even investmentq
what are the two components of break even investment>
capital depreciation and capital dilution
what is the steady state?
the steady state is the situation when adding new capital exactly equals depreciation plus the dilution. it is the point when the economy stops growing by accumulating capital per worker
what do the inada conditions and declining marginal product of capital mean for the gross investment and break even investment lines?
they imply that gross investment and break even investment lines cross only once with the actual investment crossing from above
does the economy converge to a steady state from any postive starting point?
yes it does as if capital stock is small then the marginal product of capital is high so leads to addition to capital exceeding the retirement of capital so capital stock and output increases.
if the capital stock is too high then it is relatively unproductive and therefore marginal product does not cover the physical attrition and dilution so capital stock and output decreases
what is the balanced growth path(BGP)?
it is the sequence of steady states along which all per worker variables and all absolute variables grow at a constant rate
what is the key characteristic of BGP?
all absolute variables growth at the same rate and all per worker variables grow at the same rate
what does the basic solow model show>
it shows that there is no economic growth in the steady state but there is growth during the transition from one steady state to another
it shows that the growth rate of capital should be higher in countries whihc have lower capital stocks
complete page 18-30
