Professor Steven Wood
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Problem Set 2 has been posted on bSpace and is due
at the beginning of class next Tuesday, February 15.
Today’s lecture is a continuation of Tuesday’s
lecture and examines the Solow Growth Model
further, completing Chapter 6.
Solow Growth Model: Steady State
Recall that the Solow Growth Model combines the
per-worker production function: Y/L = A
f( K / L),
the per-worker saving/investment function:
I/L = s
), and the per-worker balanced
investment function: I
/L = (
)K/L. This is
under the assumption that A is constant, so g
Based on this, we know that in the steady state, the
growth rate of the economy is the same as the
growth rate of the labor force, so g
the growth rate of capital is the same as the growth
rate of the labor force, so g
. Thus, during the
steady state, g
, so the economy is below
its steady state.
This can happen if a natural disaster destroys a
country’s capital stock, or if there is a sudden
increase in the labor force (substantial immigration
causing capital dilution). Both will result in a
decrease in K/L.
From the following graph, we can see that there is
that will move the
economy back to its steady state. If (K/L)
then at (K/L)
, we can see that investment is greater
than balanced investment, I/L > I
investment is greater than balanced investment,
capital accumulation occurs, so K/L will increase
until K/L = (K/L)
. We end up back at the original
Now let’s suppose that (K/L)
, so that the
economy is above its steady state.
This can happen if a disease kills off a large part of