Understanding The Growth Theory By Solow Economics Essay

Robert Solow was born of a Jewish family on August 23, 1924 in Brooklyn. Fortunate with the opportunity to attend public schools, he had a strong academic foundation along with with motivation and mentoring he was awarded a scholarship to attend Harvard University in 1940. During his freshman year at Harvard he chose sociology and anthropology as his majors with a minor in elementary economics. At the end of 1945 Robert Solow decided to serve in the US army and later returned to Harvard in 1945. The depression at the time strongly influenced him to study the way the economy actually worked and after returning from the army he decided to switch gears and studied economics.

At Harvard he was an assistant to Wassily Leontief producing the first set of capital coefficient for the output and input model sparking his interest in statistics and probability models which lead him to Columbia University for a concentration in statistics. About the same time he was also offered a position to lecture economics and statistics at Massachusetts Institute of Technology (MIT) which he accepted and overtime his fascination leaned more with macro economics. For 40 years Solow worked closely with Paul Samuelson and together they developed numerous work together such as: “Balanced Growth under Constant Returns to Scale”, (1953), “Theory of Capital” (1956) and “A Complete Capital Model Involving Heterogeneous Capital Goods”. In 1961, Robert Solow won the John Bates Clark Award which is given to someone under 40 years who have made a major contribution to economic thought and knowledge. His continued efforts and passion for macro economics resulted to him winning the Nobel Prize in 1987 for his analysis in economic growth.

Over the years Solow has continued to be a prominent figure as an economist, his theory is thought all over the world from government to his theory thought in schools. The study of the factors which permit production growth and increased welfare has been a central feature in economic research for many years. Robert M. Solow’s prize recognizes his exceptional contributions in this area. This paper will discuss the major contributions Robert Solow made to economics in an “A Contribution to the Theory of Economic Growth “(1956), the influences for his analysis and its relevance in understanding how the economy works.

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Understanding the Solow growth theory is a challenge due to the number of models that he incorporates to explain growth theory. The basic model focuses on the accumulation of capital after which Solow incorporates new factors such as population growth and technology in order to show the changed result in comparison to the basic model. To aid in development of his Growth Theory, Robert Solow addressed the specifics concerning the growth of an advance industrial economy, this was first developed by Nicholas Kaldor. Kaldor has six characteristics for the economy, four of which Solow focused mainly to development the Solow model.

Real output grows at a constant rate.

Capital Stock grows at a constant rate

Real growth and capital stock are likely to be the same

Profit rates show a horizontal trend with the exception of changes in effective demand.

The first three characteristics describe when an economy is in the steady state. To expand on this definition the steady state as described by Robert Solow is constant growth and capital stock.

In an article, “A Contribution to the theory of economic growth” (1956) Solow growth model represented an addition to the Harod- Domar Model which explained growth patterns in terms of savings and capital. The main differentiation between his model and the Harrod-Domar model lay in Solow’s assumption that wages could adjust to keep labor fully employed.

The Solow Model is neo-classical and as a results focuses primarily on the supply side. This implies that as long the supply of a good increases then economic growth can be accomplished. In this aspect it differs from the Keynesian models which focus on the demand side of the economy in areas such as: unemployment and inflation. The supply side In Solow’s model follows the following assumptions: One good in production with no change in technology and two factors of production, capital (K) and labor (L) deriving the following equation

Y =F (K, L). The demand side for the Solow model assumes that output demand is equal to consumption and therefore there is no disposable income in the economy. Y= C + S

Thus far the model describes a stagnant economy and Solow introduces dynamic factors in the model to show capital accumulation which are investment which increases the capital stock and depreciation which decreases capital stock. The saving rate in this model represents the tradeoff between consumption and investment. This means, what is not consumed is saved in the economy; this therefore increases capital stock growth or capital accumulation in the economy. In the active economy in the Solow model the production changes and is represented by the equation Y=F (K, S, ∂, k0) meaning output is a function of capital, savings, depreciation and capital stock. By utilizing the capital stock increases output in different periods but at some point the economy comes to a steady state as described by the Solow Model. The steady state is accomplished when output and capital are in equilibrium. It also implies that the economy will cease to grow so there is no change in capital at that point. Furthermore an economy in a positive steady state does not move from that point therefore this can also be considered as the equilibrium point

The variables listed above can be divided into two variables exogenous which comprises of savings depreciation and capital stock and endogenous which are capital, income and investments. The model shows that increased savings shifts increases investments which impacts the steady rate causing it to shift also. This activity illustrates that higher savings in an economy means that there is higher capital stock thus leading to higher steady state per worker. Therefore in the economy one need to know that is the optimum level of savings is necessary to get to maximize steady state which is known was the golden rule.

To recap, the steady state can be referred to as long run equilibrium in the economy and savings is critical in the model because it shows that by increasing savings the steady state can shift upward which asserts higher level of capital stock per worker. The concept of golden rule was also incorporated in the Solow’s Growth Theory but prior to that the golden rule was a concept by Jon von Neumann and later in the work of Edmund Phelps. In Solow’s Growth Theory, he makes the assumption that policy makers will consequently determine a savings rate that will maximize consumption per worker referring to it as the golden level of capital accumulation.

Robert Solow did not stop here with his theory he went on further to introduce population growth in his dynamic model which also means that the labor force is growing as well. What Solow is illustrating is the effect of this exogenous factor on the population. Therefore the capital stock will be divided thinly across the increasing population. Since this increase in population is decreasing the capital stock this indicates there is a negative effect on income per worker. Solow then adds technology to the model, technology as described by Solow can improve efficiency of production and this means that there is an increase in output ultimately leading to the sustained growth in the economy. At this stage in the model, Solow uses a new production function to describe the economy Y=F (K, L, E, €) this means that output is a function of capital, labor, efficiency and effective worker for this economy. Solow goes on to describe what is meant by an efficient worker and this is characterized by knowledge, familiarity and ability. Output can consequently increase by the efficiency levels of workers. Efficiency in this model per effective worker can move the steady state equilibrium where capital stock per worker constant. As a result, with technological progress in this model the capital stock per worker is growing at the technology rate even in the steady state due to efficiency in the economy. We can see that even if capital is not growing in the steady state capital per effective worker is at the rate of technology. In addition, this also asserts that output per worker is also growing at a rate of technology. Combined, total output and capital stock are both growing when the two variables population and technology are present. The Solow Model therefore shows that technological progress in the economy explains sustained economic growth in the context of living standards per worker.