Solow Growth Model

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Solow model - how well it holds in the real world?

Prepared by:-

Amol Rattan (75013)

Introduction

Prior to Solow Model, Harrod Domar model had shown how the savings rate could play a crucial role in determining the Long run rate of Growth. Solow model however proved a result that was contrary to what Harrod Domar model had predicted.

It showed that savings has only level effect on income and the growth rate of income depends upon the rate of efficiency or technical progress in the country.

Solow Model relies on certain assumptions
1. There are constant returns to Scale(CRS)
2. The production function is standard neoclassical production function with diminishing returns to factor 3. The markets are perfectly competitive
4. Households save at a constant savings rate ‘s’

Equilibrium in Solow Model is defined as the steady state level of capital where the economy grows at a constant rate. By assuming that the two factors of production are capital and labour per efficiency unit, it can be shown that savings only affects the level of per capita income. It is only the rate of growth of efficiency which determines the rate of growth of per capita output.

For production function: Y= KαL1-α

Steady state values are:

y•=[s/π+δ+n]α/1-α

k• =[s/π+δ+n]1/1-α

Objective
i) To find how true the result of convergence of Solow model holds for a sample of countries of the world ii) Test Solow model for India for the period 1990-2008

Methodology
i) To find how true the result of convergence of Solow model holds for a sample of countries of the world

• To prove: Convergence result

Solow model predicts that all nations with same parameter of savings rate, population growth rate and depreciation rate will all grow at the same rate in long run. This implies
A) The rich...
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