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EC1B3 > Week 3: Solow Growth Model > Flashcards

Week 3: Solow Growth Model Flashcards

1
Q

Exogenous Variable

A

variable is given in model and is determined outside of the model

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2
Q

Endogenous Variable

A

variable that is determined by the model

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3
Q

Solow Growth Model

A

exogenous model of economic growth that analyses changes in the level of output in an economy over time

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4
Q

How is Solow Growth Model Different to Production Function? (3)

A

Augments production model with capital accumulation
Capital stock if no longer exogenous (variable given)
capital stock now endogenised (variable determined in model)

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5
Q

How do you set up the Solow Growth model?

A

Use old production function equation and add an equation for the accumulation of capital over time

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6
Q

Key aspects of the Solow Growth Model equation? (4)

A
  • cobb douglas method
  • constant returns to scale in capital and labour
  • assume exponent of one third on capital
  • all variable are time subscribed by t
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7
Q

What does a resource constraint assume?

A

Assumes no imports or exports and no gov spending

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8
Q

Resource Constraint Equation

A

C(t) + I(t) = Y(t)
C = consumption
I = investment

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9
Q

Capital Accumulation Equation

A 
K(t+1) = K(t) + I(t) - dK(t) 
K(t+1) = next years capital 
K(t) = this years capital 
I(t) = this years investment 
d = depreciation rate
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10
Q

Capital Accumulation

A

an increase in assets from investments or profits

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11
Q

Change in Capital Stock Equation

A

△K(t=1) = K(t+1) - K(t)
Thus
△K(t=1) = I(t) - dK(t)

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12
Q

Is labour supply an endogenous variable in Solow Growth Model?

A

No for simplicity - amount of labour in economy is given exogenously at a constant level
L(t) = L

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13
Q

Consumption Equation in Solow Growth Model

A 
I(t) = sY(t)
I = investment 
s = fraction of total output invested

C(t) = (1-s)Y(t)

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14
Q

Saving Equation in the Solow Growth Model

A

Difference between income and consumption
Y(t) - C(t) = I(t) is saving Y(t) - C(t)
saving = investment

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15
Q

Two ways to solve Solow Growth model

A
  1. Graphical solution

2. Solve model in the long run

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16
Q

What happens at the rest point of the economy?

A

All endogenous variables are steady

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17
Q

In the steady state what is investment equal to?

A

investment = depreciation

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18
Q

Mathematical solution for the Steady State

A

Nul and void

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19
Q

What is the steady state level of capital positively related to? (3)

A
  • investment rate
  • size of the workforce
  • productivity of the economy
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20
Q

What is the steady state level of capital negatively related to?

A

depreciation rate

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21
Q

What is a higher steady state production caused by?

A

Higher productivity and investment rate (s and A)

22
Q

What is a lower steady state production caused by?

A

faster depreciation

23
Q

Why does an economy reach a steady state?

A
  • investment has diminishing returns
24
Q

What is an important result from the Solow Growth Model?

A

No long-run growth

25
Q

Drawback in the model regarding long-run growth

A
  • after we reach the steady state there is no long-run growth in output
26
Q

Can growth in the labour force lead to overall economic growth?

A

Yes - in the aggregate

No - cannot in output per person

27
Q

What happens to output in response to an increase investment rate? (2)

A
  • capital accumulates over time

- Capital stock increases by transition dynamics to reach new steady state

28
Q

What happens to output in response to a rise in depreciation rate?

A
  • decline in output which is rapid at first and then settles at a new lower steady state
29
Q

What happens if an economy is 1. below steady state 2. above steady state?

A
  1. it will grow

2. negative growth rate

30
Q

What is growth like in economy when far below steady state?

A

the further below the faster the growth

31
Q

What is growth like in economy when close to steady state?

A

slower the economy will grow

32
Q

Strengths of the Solow Model

A
  • provides a theory that determines how rich a country is in the long run
  • allows us to understand difference in growth rates across countries
33
Q

Weaknesses of Solow Model (3)

A
  • main focus on investment and capital TFP is much more important but is unexplained
  • does not explain why different countries have different investment and productivity rates
  • does not provide a theory of sustained long-run economic growth
34
Q

How do you solve the Solow growth model? (2 steps)

A
  1. combine the investment allocation and capital accumulation equation
  2. sub fixed amount of labour into production function
35
Q

Diagram that shows economy moving towards steady state

A
36
Q

What happens to solow growth model when investment > depreciation

A
  • capital stock will increase until the amount of investment = amount of capital that wears out due to depreciation
  • hence change in capital = 0
  • capital stock will stay at this value of capital forever - steady states
37
Q

Solow growth model diagram with output

A
38
Q

What happens if economy is below steady state?

A

economy will grow

39
Q

What happens if economy if above steady state?

A

the growth rate of the economy will be negative

40
Q

What does it mean when the economy is far below the steady state?

A

the further below, the faster the economy will grow

41
Q

What does it mean when an economy is close to the steady state?

A

the closer to the steady state, the slower the economy will grow

42
Q

Solow Growth Model - Diagram when there is an increase in investment rate

A
43
Q

Solow Growth Model - Diagram when there is an increase in depreciation rate

A
44
Q

How can you have a negative growth rate in the economy?

A

If GDP falls from one quarter to the next then growth is negative

45
Q

Short run results of foreign aid on the economy when k* > k0
(steady state > aid)

A
  1. Amount of capital per worker will immediately increase to k0 + f - staying on the left of the steady state
  2. Output per worker increases from Af(K0) to Af (K0 +f)
  3. Growth rate will decrease as MPK is lower
46
Q

Long run results of foreign aid on the economy when k* > k0

steady state > aid

A

Economy will converge to the same steady state as before

47
Q

Diagram for the results of foreign aid on the economy when k* > k0
(steady state > aid)

A
48
Q

Short run results of foreign aid on the economy when k* = k0
(steady state = aid)

A
  1. Amount of capital per worker will immediately increase to k* + f - moving to the right of the SS
  2. Output per worker increases from Af(K) to Af (K +f)
  3. Growth rate will be negative
49
Q

Long run results of foreign aid on the economy when k* = k0

steady state = aid

A

Economy will converge to the same steady state

50
Q

Diagram showing results of foreign aid on the economy when k* = k0
(steady state = aid)

A
51
Q

Is there a permanent effect of foreign aid?

A

no

52
Q

What needs to happen in order for their to be a permanent change to the steady state?

A

There needs to be a change in the parameters for their to be a change in the steady state for example s or A

EC1B3 (10 decks)

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