The Solow Growth Model
14 April 2014
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Economic growth rates across countries are hardly ever the same and the Solow-growth model is the starting point at determining why growth rates differ across countries (Burda and Wyplosz, 2013: 61). This essay aims at examining the aspects of the Solow-Growth model of economic growth while highlighting the strengths and weaknesses and identifying whether or not capital accumulation has been the main cause for economic growth in South Africa. This will be achieved through examining economic growth with capital-stock growth, population growth and technological progress. The Solow-growth model measures growth rates of different economies and according to Solow, it is the starting point to determining why these growth rates differ across economies (Burda and Wyplosz, 2013). The Solow-growth model is an exogenous growth model which means variables are determined outside the field under study, making it a traditional Neo-classical growth model (Liu, 2007: 6). The Solow-growth model examines the economy and its growth rates by examining and comparing results from capital accumulation, population growth and technological progress (Burda and Wyplosz 2013: 61-77). The growth phenomenon works like this: Savings accumulated from households flows into financial systems which in turn channels these savings to borrowers (Burda and Wyplosz, 2013: 61). Firms borrow these savings in the form of capital goods that will aid them in production processes (Burda and Wyplosz, 2013: 61). Assuming that the economy’s capital stock is ultimately financed by households’ savings, let us examine the economy’s Steady State when there is no population growth or technological progress involved. The Steady State below relates an economy’s output to inputs of capital and labour (Burda and Wyplosz, 2013: 63). The change in capital (k) that is the vertical distance between the savings schedule and the depreciation line represents the net change in the capital stock per unit of labour input in the economy (Burda and Wyplosz, 2013:63). This means that for every additional hour of work, there is an effect on the capital stock of the economy. Characterised by certain macroeconomic variables remaining constant, the steady state in an economy is a point where conditions are stable (Burda and Wyplosz, 2013). As seen in figure 1, if capital stock is below the steady state level, then investment is greater than depreciation and capital would have to increase until it reaches the steady state level (Sanders, 2008: 1). This is done by saving more so that depreciation is covered and the economy is able to invest in new capital (Sanders, 2008:1). On the other hand, if the economy is above the steady state and investment is less than depreciation, not enough is being saved to cover both depreciation and capital therefore capital stock per capita and output per capita decrease (Burda and Wyplosz, 2013: 63). This is the effect of diminishing returns (Burda and Wyplosz, 2013: 58). When investment and depreciation intersect at point A, capital stock per capita and output per stock growing and the economy is at its steady state (Burda and Wyplosz, 2013: 63). This means capital cannot be key to economic growth if it eventually stops accumulating. Figure 2 is the steady state with population growth, investment has an extra job which is to not only to compensate for depreciation, but now must provide for new workers in the economy (Burda and Wyplosz, 2013: 70). This is called capital-widening and is represented by a steeper depreciation line which means investments need to increase (Burda and Wyplosz, 2013: 70). Therefore, the steady-state falls when there are enough investments to cater for depreciation and the...
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