The Solow Model Part 2

The Solow Model Part 2

The Solow Model Part 2
 if the economy is BELOW its steady-state
Suppose (K/L)1 < (K/L)S

1. If (K/L)1 < (K/L)S, then at (K/L)1, I/L > IB/L

2. If I/L > IB/L, then K/L will increase.

if the economy is ABOVE its steady-state

The Solow Model Part 2 Suppose (K/L)1 > (K/L)S

1. If (K/L)1 > (K/L)S, then at (K/L)1, I/L < IB/L

2. If I/L < IB/L, then K/L will decline.

Steady state is the long-run equilibrium for the economy.

 1. An increase in the saving rate rotates the per-worker
investment (and saving) function up.

2. At the initial K/L at (K/L)S, I/L > IB/L

3. Consequently, K/L
Changes in the Saving
Rate, s 4. As K/L increases:

a. Y/L along the production function,

b. I/L along the new investment function, and

c. IB/L along the balanced investment function.

 3. During the transition period between S and S1?
Because Y/L is gY > gL0.

If saving rate, s,
Then
K/L

Changes in the Saving Y/L

Rate, s
Faster growth during the transition period

No change in long-term economic growth rate

 gL ,
1. Slower labor force growth rate rotates the per-
worker balanced investment function down.

2. At the initial K/L at (K/L)S, I/L > IB/L.

Changes in the Labor 4. As K/L increases:

Force Growth Rate, gL
a. Y/L along the production function,

b. I/L along the investment function, and

c. IB/L along the new balanced investment

function.

gL1 < gL0

gY1 < gY0
 4. the transition period between S and S1?

Because Y/L was increasing, gY > gL1

If the labor grwoth rate is slower,

Then
K/L

Changes in the Labor Y/L

Force Growth Rate, gL
Faster growth during the transition period

1. A slower long-term economic growth rate.

 If A

1. An increase in productivity, A, rotates both the per-

worker production and the per-worker investment
functions up.

2. At the original K/L at (K/L)S, Y/L is now higher.

Productivity Change in 3. Also at the original K/L at (K/L)S, I/L > IB/L
the Solow Model
4. As K/L increases:

a. Y/L increases along the new production

function,

b. I/L increases along the new investment function,

and

c. IB/L increases along the balanced investment

function.
 3. During the transition period between S and S1?

a. Because Y/L is increasing gY > gL0, and

b. Because K/L is increasing gK > gL0.

If productivity,
Productivity Change in Then
the Solow Model K/L

Y/L

Faster growth during the transition period

No change in long-term economic growth rate