Endogenous growth theory emerged in the 1990s as ‘new growth theory’ accounting for technical progress in the growth process (ARMSTRONG and TAYLOR, 2000). In 1990, Paul Romer explores this uncharted territory, linking technical progress to production of knowledge by research and development (R&D) workers at profit-seeking firms. A key assumption in his model is a positive association between the rate of productivity growth and the stock of R&D workers (Izushi, 2008). They are research sector, intermediate sector and final goods sector. Research sector is like research labs or departments that produce ideas. Intermediate sector takes those ideas to make tools and machines. Final good sector uses ideas to produce consumer goods.
Summary of Romer I
Different from Solow model, Romer gives up the assumption of diminishing marginal returns and builds up his model with the assumptions: constant returns to rival inputs and constant returns to ideas. He believes that the source of economic growth is research and development or ideas. There are three sectors in the Romer’s endogenous growth model. Thus, it must devote some labors to the research sector from current production.
As a result, higher the growth rate of population more people can work in the research sector, and stock of knowledge increases as output rises. Motivation of Romer II
Under the assumption and result from Romer I, it is necessary to devote resources which cannot be used to produce output to research and development for technology change. Therefore, two modifications appear to be important to the Romer model I. One is to determine the percentage of labor and capital that used for research. The other is to find out how these resources transformed into research. Compare to Romer I, there are two major differences. One is the additional assumption of capital as an input of technology. That is to say, a portion of capital cannot be used to produce output...