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Solow Growth Model - Essay Example

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SOLOW GROWTH MODEL Institution Tutor Date Introduction Economic growth is defined as increased capacity of a country’s economy to produce goods and services in comparison to a previous period and is measured by the gross domestic product (Song, 2009, p…
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Solow Growth Model
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Solow Growth Model

Download file to see previous pages... Solow Growth Model is a standard neoclassical model of economic growth developed by Robert Solow. This model holds that economic growth is linked to capital accumulation and the population growth (Zhuang and St Juliana, 2010, p. 65). Solow growth model postulates that under equilibrium, the level of per capita income is determined by prevailing technology, rates of saving, rate of population growth and technical progress all which are assumed exogenous (Barossi-Filho, 2005, p. 37). Given that the rates of population growth and levels of saving are varying across countries, the model gives testable predictions on assessing how the two can influence economic growth of countries. Solow model has been criticized by different theorists given the assumptions made by this theory. This paper will explain the impacts of both population growth and increase in the saving rates upon economic growth. Moreover, the paper will explain how Solow model accounts for technological progress and assess whether Romer model improves on this. Impact of both population growth and an increase in the savings rate upon economic growth Increased production of goods and services leads to economic growth. In the light of this statement, any country that desires to achieve economic growth must have optimal factors of production (Song, 2009, p. 7). The factors of production include capital, labor, technology, land and entrepreneur. When these factors are optimized economic growth of the country will be positive. Solow growth model predicts that economic growth results from accumulation of capital and population growth rate (Zhuang and St Juliana, 2010, p. 65). Moreover, the model starts by making an assumption of capital accumulation is subject to diminishing returns (Stein, 2007, p. 193). Solow model argues that developing countries with low capital stock can achieve higher economic growth compared to developed countries by increasing their savings and investment rates. Solow model postulates that increased rates of savings leads to capital accumulation. The theory behind increased savings resulting in capital accumulation is that higher savings leads increased amount of funds that can be offered as credit for capital investment. Consequently, this borrowed capital will be invested in the production industry and therefore the gross domestic products will be higher (Song, 2009, p. 9). Investment is required for the development of infrastructure required for production. However, Liu and Guo (2002, p. 25) argues that economic growth of a country depends on its ability to deploy the savings to finance capital investment. In the Solow model, the second factor identified to influence economic growth of a country is its population growth. Population provides an important factor of production; labor and consequently as population grows it adds to the available labor it contributes to economic growth of any country. However, given the rule of diminishing returns on factors of production it is necessary to strike equilibrium between the labor and other factors of production (Song, 2009, p. 10). The combined effect of impact of increased rates of saving and population growth can be understood using the Solow model. This model offers testable predictions since these two factors are different across nations. Song (2009, p. 9) argues that countries having high saving levels usually have higher per capita incomes while those experiencing high population growth have lower per capita inco ...Download file to see next pagesRead More
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