Solow Growth model

Solow growth model shows how the saving rate; population growth and technology affects the level of output and growth of the economy. According to this production function is y = f(k) where y is the output per worker which is a function of capital per worker.

Demand for goods comes from consumption and investment where AD = C+I in closed economy. Thus solow model assumes that individual save a fraction income thus S = sy and rest use for consumption; therefore; Y = c+sy; -> y(1-s) = C substituting value of C in demand function we get y(1-s)+I = Y -> ys= i. According to this investment is dependent on rate of saving.

According to solow; increase in investment rate leads to increase in capital stock and also leads to increase in depreciation. Thus a stage where investment is equal to depreciation is “steady state” where every economy wants to reach for the development of the economy.

How saving plays a role to reach steady state?

Thus if saving increase it leads to increase in investment which leads to increase in capital stock and finally increase the depreciation; thus process continues till economy reach to the new steady state. Where net effect is zero called golden rule of capital where consumption maximise.

According to solow; population growth (n) is also a negative factor higher the population lower will be the capital stock (k) because now more people are equipped with same capital leads to diminishing returns and the steady state of capital will be i = (d+n)k where (d) is depreciation and net return on investment will be zero.

The conclusion of the model is :-

Technology growth leads to the development of economy with the increase in population because if population increase and technology increase; the economy will reach to the steady state and capital stock will increase permanently as it raises the efficiency of labour.

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