The Solow Model

 

The economist Robert Solow (pictured) developed the neo-classical theory of economic growth. Solow won the Nobel Prize in Economics in 1987. 

 

A single good (output) is produced using two factors of production, labor (L) and capital (K)in an aggregate production function that satisfies the Inada conditions, which imply that the elasticity of substitutionmust be asymptotically equal to one.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Growth comes from adding more capital and labour inputs and also from ideas and new technology. The Solow model believes that a sustained rise in capital investment increases the growth rate only temporarily: because the ratio of capital to labour goes up. 

 

However, the marginal product of additional units of capital may decline (there are diminishing returns) and thus an economy moves back to a long-term growth path, with real GDP growing at the same rate as the growth of the workforce plus a factor to reflect improving productivity.

 

Reference:

 

Geoff Riley.  Economic Growth - the Solow Model. 2013. http://beta.tutor2u.net/economics/blog/unit-4-macro-economic-growth-the-solow-model

 

Eklund J E. Theories of Investment: A Theoretical Review with Empirical Applications[C]//Swedish Entrepreneurship Forum, Working Papers Series. 2013.