Growth Model

The Neo-classical model was an extension to the Harrod-Domar model that included a new term, productivity growth. The most important contribution was probably the work done by Robert Solow; in 1956, Solow and T.W. Swan developed a relatively simple growth model which fit available data on US economic growth with some success[1]. Solow received the 1987 Nobel Prize in Economics for his work on the model.

[edit] Extension to the Harrod-Domar model

Solow extended the Harrod-Domar model by:

* Adding labor as a factor of production;

* Requiring diminishing returns to labor and capital separately, and constant returns to scale for both factors combined;

* Introducing a time-varying technology variable distinct from capital and labor.

The capital-output and capital-labor ratios are not fixed as they are in the Harrod-Domar model. These refinements allow increasing capital intensity to be distinguished from technological progress.

[edit] Short run implications

* Policy measures like tax cuts or investment subsidies can affect the steady state level of output but not the long-run growth rate.

* Growth is affected only in the short-run as the economy converges to the new steady state output level.

* The rate of growth as the economy converges to the steady state is determined by the rate of capital accumulation.

* Capital accumulation is in turn determined by the savings rate (the proportion of output used to create more capital rather than being consumed) and the rate of capital depreciation.

Bibliography