Econ 204A, Introduction to
Part 2:
The Solow Model and New
Growth
Henning Bohn*
The Solow model describes the mechanics of production and capital accumulation. Though the model is a non-optimizing model of the economy that predates the rational expectations revolution, it lays the foundations for dynamic macroeconomics. Virtually all state-of-the-art macroeconomic models include a production sector that combines capital and labor to produce output. The Solow model provides a convenient way to introduce standard assumptions about production while keeping the demand-side simple—indeed ridiculously simple. The demand side is fully described by the assumption of a constant savings rate. To anticipate, many optimizing models examined later will turn out to have a fairly ÔstableÕ savings rate. This makes the model useful for describing (though not really explaining) the process of economic growth.
Key concepts will be the steady state, balanced growth, convergence, and returns to scale. Part 2 should take about two weeks.
The Solow model is covered in Romer, ch.1. Good alternative expositions of the Solow model are in Barro and Sala-i-Martin ch.1 (graduate level), Jones ch.1-3 (easier). Mankiw-Romer-Weil is a famous empirical paper that we will discuss as example of empirical work in macro.
The Solow model assumes an exogenous rate of productivity growth. This simplifying assumption is relaxed in New Growth models; they endogenize productivity growth by studying research and development. I will only introduce the topic — a more in depth discussion of New Growth would easily fill a course — following the exposition in Jones ch.4-5. Romer ch.3 is an alternative exposition.