✤ Solow Growth Model has three components: per worker production function (real
functions), per worker investment/saving function (real function), per worker
balanced investment line (hypothetical situation)▯
✤ What happens if any components of the model change?▯
✤ Endogenous and Exogenous variables▯
✤ We are going to change the exogenous variables one by one to see what their
effects are▯
✤ In the simple Solow Model, we assume that productivity is constant▯
✤ Intersection between actual investment per worker and balanced investment per
worker leads to the steady state▯
✤ Use the intersection point to lead to the production function to ﬁnd the output per
worker or income per worker▯
✤ If we are at the steady state, we are at a stable economic equilibrium▯
✤ This means that we are at the steady state, there are not any economic forces that
will make us move from that position; and if we are not at the steady state, there will
be economic forces that will make us approach the steady state▯
✤ The K:L can fall below the steady state for two reasons:▯
✤ 1. the capital could decline 2. the labour force could increase▯
✤ A fall in the K:L ratio results in the reduction of output/income per worker, and
therefore the productivity▯
✤ Implication of balanced investment > actual investment => capital stock will start to
rise => K/L will rise => income per worker starts to recover▯
✤ As K/L and income rise: 1.) actual saving/investment increase along the per worker
line, 2.) balanced investment line, has also increased▯
✤ Actual investment > Balanced investment = as long as we are still investing, the K/L
ratio will rise some more, and eventually we will get to the original K/L▯
✤ Economic output per worker goes back to its original level, saving and actual
investment continue to increase until they get back to their original value, balanced
investment also moves▯
✤ When actual investment = balanced investment▯
✤ = steady state▯
✤ ^^ Example: recovery from the Earthquake▯
✤ ^^ assuming that productivity is constant▯
✤ How do we know if the economy grows more equally between two cases?▯
✤ 1. when we are at k/L1, we have a huge gap between actual & balanced investment ▯
✤ As we move closer to the steady state, the gap between actual & balanced
investment gets smaller = change in economic activity will be lesser▯
✤ 2. Per worker production function has diminishing returns to capital - so as K:L rises
from a relatively low of level, the increase in income per worker will be on the
steeper part of the production function and income per worker will rise a lot▯
✤ as we get closer to the steady state, further increases only increases a little slowly▯
✤ Magnitude in change in

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