Macro Solow

Econ 2110:
Chapter 1
Hanley
1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
Chapter 1 - Solow model
2.2 Economic
equilibrium
Advanced Macroeconomic Theory I
2.3 Firm optimization
2.4 Dynamic
equations
2.5 Steady state
Douglas Hanley
2.6 Transitional
dynamics
3 Solow model University of Pittsburgh

with growth
3.1 Balanced growth
3.2 Technological
change
Fall 2016
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
1 / 76
Econ 2110:
Chapter 1
Hanley
1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
Long-run facts
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
2 / 76
Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts
1.1 Growth facts • 10,000 years ago: all (but a tiny fraction) of humanity was
1.2 Kaldor facts
poor
2 Basic Solow
model • Prior to 1800: living standards differed little across countries
2.1 Economic
environment and across time (Parente and Prescott, 2000)
2.2 Economic
equilibrium • After 1800: while some countries started to double their per
2.4 Dynamic capita income every 35 to 40 years, in others income
equations
2.5 Steady state remained stagnant:
2.6 Transitional
dynamics
3 Solow model Country Income 1820 * Income 1913

with growth
3.1 Balanced growth
UK 1,700 5,000
3.2 Technological
change
Netherlands 1,600 4,000
3.3 Dynamics Germany 1,100 3,900
4 Solow model in
continuous time
*1990 intl. dollars - Azariadis and Stachurski (2005)
4.1 Steady State
4.2 Examples
3 / 76
Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
• After 1800:
2.1 Economic
environment Per capita income in the West and East
2.2 Economic
equilibrium
Year West East West/East
2.4 Dynamic
equations
1820 1,140 540 2.1
2.5 Steady state 1913 3,590 740 4.8
2.6 Transitional
dynamics 1950 5,450 727 7.5
3 Solow model
with growth
1992 13,790 3,240 4.3
3.1 Balanced growth
3.2 Technological Source: Parente and Prescott (2000)
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
4 / 76
Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
• Stylized facts for the 1960-2000 period (Durlauf, Johnson
model
and Temple, 2005):
2.1 Economic
environment
2.2 Economic
• most countries have grown richer but large disparities remain
equilibrium
• for all but the richest group, growth rates have differed to an
2.4 Dynamic
unprecedented extent, regardless of the initial level of
equations
2.5 Steady state
development
2.6 Transitional • although past growth is a weak predictor of future growth,
dynamics
clear winners and losers have emerged
3 Solow model
with growth • for most countries growth rates were slower in 1980-2000
3.1 Balanced growth than in 1960-1980
3.2 Technological
change • the dispersion of growth rates has increased
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
5 / 76
Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts Evolution of GDP distribution
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
6 / 76
Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts Recent Evolution of GDP distribution
1.1 Growth facts
1.2 Kaldor facts
.4
2 Basic Solow
model 1960
2.1 Economic
environment 2000
.3
2.2 Economic 1980

equilibrium
Density of coutries

2.4 Dynamic
equations
.2
2.5 Steady state

2.6 Transitional
dynamics
3 Solow model
with growth
.1
3.1 Balanced growth

3.2 Technological
change
3.3 Dynamics
0
4 Solow model in
continuous time 6 7 8 9 10 11
log gdp per capita
4.1 Steady State
4.2 Examples
7 / 76
Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts Major Country Dynamics
1.1 Growth facts
1.2 Kaldor facts
GDP Per Capita (Relative to US)
2 Basic Solow
0
model
2.1 Economic
environment
2.2 Economic
equilibrium 1
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
2
dynamics
3 Solow model
with growth
USA
FRA
3.1 Balanced growth 3 JPN
3.2 Technological
change CHN
3.3 Dynamics IND
BRA
4 Solow model in
continuous time
4
4.1 Steady State 1950 1960 1970 1980 1990 2000 2010
4.2 Examples
Source: Penn World Tables (8.1) 8 / 76

Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples Source: Durlauf, Johnson and Temple (2005)
9 / 76
Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
10 / 76
Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
11 / 76
Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
12 / 76
Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
OECD 19601980 OECD 19802000
2 Basic Solow GRC IRL
model 0.06 JPN 0.030
ESP FIN
2.1 Economic
environment 0.05 ITA 0.025
PRT JPNGBR LUX
AUT NOR
2.2 Economic
0.04 FRA 0.020 SWE
Growth
equilibrium FIN IRL BEL PRT NZL DNK

DEU NLD DEUAUT USA
2.3 Firm optimization ITABEL
0.03 ISL NOR
0.015 FRA
ESP AUSCAN
2.4 Dynamic DNK
equations SWE
2.5 Steady state
0.02 GBR LUX CHE
AUS USA 0.010 ISL NLD
CAN
2.6 Transitional
dynamics
0.01 NZL 0.005 GRC CHE
3 Solow model 1.0 0.5 0.0 0.50 0.25 0.00 0.25

with growth Relative Level Relative Level
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics Source: Penn World Tables (8.1)
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
13 / 76
Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
14 / 76
Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
15 / 76
Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State Source: Durlauf, Johnson and Temple (2005)
4.2 Examples
16 / 76
Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts • Facts suggest a role for international knowledge flows
2 Basic Solow
model
(Klenow and Rodriguez-Clare, 2005):
2.1 Economic
environment
• countries appear to be subject to the same long-run growth
2.2 Economic
equilibrium
rate
2.3 Firm optimization • growth slowdown that began in the early 1970s was
2.4 Dynamic
equations
world-wide
2.5 Steady state • countries with high investment rates exhibit higher income
2.6 Transitional
dynamics levels more than higher growth rates
3 Solow model • differences in country incomes and investment rates are
with growth
highly persistent
3.1 Balanced growth
3.2 Technological • investment includes physical capital, human capital and
change
3.3 Dynamics R&D
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
17 / 76
Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
Source: Klenow and Rodriguez-Clare (2005)
4.2 Examples
18 / 76
Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
19 / 76
Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
20 / 76
Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples Source: Klenow and Rodriguez-Clare (2005)
21 / 76
Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
22 / 76
Econ 2110:
Chapter 1
Hanley Growth facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
23 / 76
Econ 2110:
Chapter 1
Hanley Kaldor facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
• Nicholas Kaldor (1957)
environment
2.2 Economic • Long-run stylized facts for industrialized countries:
equilibrium
1 growth rate of per capita output constant over time
2.4 Dynamic
equations 2 capital-output ratio constant
2.5 Steady state
2.6 Transitional
3 rate of return on capital constant
dynamics 4 capital and labor share of income constant
3 Solow model
with growth
5 constant saving rate
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
24 / 76
Econ 2110:
Chapter 1
Hanley Kaldor facts

1 Long-run facts Nicholas Kaldor 1908-1986
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
25 / 76
Econ 2110:
Chapter 1
Hanley Kaldor facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
26 / 76
Econ 2110:
Chapter 1
Hanley Kaldor facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
27 / 76
Econ 2110:
Chapter 1
Hanley Kaldor facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
28 / 76
Econ 2110:
Chapter 1
Hanley Kaldor facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
29 / 76
Econ 2110:
Chapter 1
Hanley Kaldor facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
30 / 76
Econ 2110:
Chapter 1
Hanley Kaldor facts

1 Long-run facts • Kaldor facts in the US no more? → including intangible
1.1 Growth facts investment
1.2 Kaldor facts
2 Basic Solow
• business expenditures aimed at enhancing the value of a firm
model and improving its products
2.1 Economic
environment • examples: R&D, employee training, computer software,
2.2 Economic
equilibrium
strategic planning
• Corrado, Hulten and Sichel (2006) →
2.4 Dynamic
equations
2.5 Steady state • NIPAs historic practice
• intangibles are intermediate expenditures, and not part of
2.6 Transitional
dynamics
3 Solow model investment

with growth
• no measure of capital stock of intangibles
3.1 Balanced growth
3.2 Technological • why this practice? → non-verifiability, non-rivalness,
change
3.3 Dynamics non-appropriability
4 Solow model in • Solow (1987): “you see the computer revolution everywhere
continuous time
except in the productivity data”
• mid 1990s → capitalization of software included in NIPAs
4.1 Steady State
4.2 Examples
31 / 76
Econ 2110:
Chapter 1
Hanley Kaldor facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
• Changes in Kaldor facts:
2.2 Economic
equilibrium
• investment shares
2.4 Dynamic
equations
• capital-output ratio
2.5 Steady state • labor share
2.6 Transitional
dynamics
• growth rate of output per worker
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
32 / 76
Econ 2110:
Chapter 1
Hanley Kaldor facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State Source: Corrado, Hulten and Sichel (2006)
4.2 Examples
33 / 76
Econ 2110:
Chapter 1
Hanley Kaldor facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples Source: Corrado, Hulten and Sichel (2006)
34 / 76
Econ 2110:
Chapter 1
Hanley Kaldor facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
Source: Corrado, Hulten and Sichel (2006)
4.2 Examples
35 / 76
Econ 2110:
Chapter 1
Hanley Kaldor facts

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples Source: Corrado, Hulten and Sichel (2006)
36 / 76
Econ 2110:
Chapter 1
Hanley Kaldor facts

1 Long-run facts Historical Labor Share
1.1 Growth facts
1.2 Kaldor facts 0.70
2 Basic Solow
model
2.1 Economic
0.65
environment
2.2 Economic
equilibrium 0.60
2.4 Dynamic
equations
2.5 Steady state
0.55
2.6 Transitional
countrycode
0.50
dynamics
3 Solow model
USA
with growth FRA
JPN
3.1 Balanced growth
0.45 CHN
3.2 Technological
change IND
3.3 Dynamics
4 Solow model in 1950 1960 1970 1980 1990 2000 2010

continuous time
4.1 Steady State
4.2 Examples Source: Penn World Tables (8.1)
37 / 76
Econ 2110:
Chapter 1
Hanley Kaldor facts

1 Long-run facts Investment Share of Income
1.1 Growth facts 0.5 countrycode
1.2 Kaldor facts USA
2 Basic Solow FRA
model JPN
2.1 Economic
0.4 CHN
environment
IND
2.2 Economic
equilibrium
2.4 Dynamic
0.3
equations
2.5 Steady state
2.6 Transitional
dynamics
0.2
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change 0.1
3.3 Dynamics
4 Solow model in 1950 1960 1970 1980 1990 2000 2010

continuous time
4.1 Steady State
4.2 Examples Source: Penn World Tables (8.1)
38 / 76
Econ 2110:
Chapter 1
Hanley
1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
Basic Solow model

environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
39 / 76
Econ 2110:
Chapter 1
Hanley Economic environment

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
40 / 76
Econ 2110:
Chapter 1

1 Long-run facts • First proposed by Robert Solow in 1956
1.1 Growth facts
1.2 Kaldor facts • Closed economy, with a single final good
• Discrete time running to an infinite horizon, time is indexed
2 Basic Solow
model
2.1 Economic
environment
by t = 0, 1, 2, . . .
2.2 Economic
equilibrium • Economy is inhabited by a large number of agents:
2.4 Dynamic • they invest a constant exogenous fraction s of their income
equations
2.5 Steady state
2.6 Transitional
• All firms have access to the same production function:
dynamics
3 Solow model • aggregate production function for final good is

with growth
3.1 Balanced growth
Y (t ) = F [K (t ), L(t ), A(t )]
3.2 Technological
change
3.3 Dynamics • capital is used in production, and can be made one-for-one
4 Solow model in
continuous time
from the final good
4.1 Steady State
• technology is assumed to be a public good
4.2 Examples
41 / 76
Econ 2110:
Chapter 1

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow • Assumption 1. Properties of the production function

model
2.1 Economic
The production function F : R3+ → R+ is twice
environment
continuously differentiable in K and L, and satisfies
2.2 Economic
equilibrium
∂F (·) ∂F (·)
2.4 Dynamic FK (K , L, A) ≡ > 0, FL (K , L, A) ≡ > 0,
equations
2.5 Steady state
∂K ∂L
∂2 F (·) ∂2 F (·)
FKK (K , L, A) ≡ FLL (K , L, A) ≡
2.6 Transitional
dynamics < 0, < 0.
3 Solow model ∂K 2 ∂L2
with growth
3.1 Balanced growth • Moreover, F exhibits constant returns to scale in K and L
3.2 Technological
change (it is homogeneous of degree 1 in K and L)
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
42 / 76
Econ 2110:
Chapter 1

1 Long-run facts • Definition 2.1. Homogeneity
1.1 Growth facts
1.2 Kaldor facts
The function g : R2 → R is homogeneous of degree m if
2 Basic Solow and only if for all (x, y ) ∈ R2 and λ ∈ R+
model
2.1 Economic
environment g (λx, λy ) = λm g (x, y )
2.2 Economic
equilibrium
2.3 Firm optimization • Theorem 2.1. Euler’s theorem
Suppose that g : R2 → R is continuously differentiable in
2.4 Dynamic
equations
x ∈ R and y ∈ R, with partial derivatives denoted by gx

2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
and gy and is homogeneous of degree m. Then
with growth
3.1 Balanced growth mg (x, y ) = gx (x, y )x + gy (x, y )y
3.2 Technological
change
3.3 Dynamics
for all x ∈ R and y ∈ R.
4 Solow model in
continuous time Moreover, gx (x, y ) and gy (x, y ) are themselves
homogeneous of degree m − 1.
4.1 Steady State
4.2 Examples
43 / 76
Econ 2110:
Chapter 1
Hanley Economic equilibrium

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model • Markets are competitive
• Labor market:
2.1 Economic
environment
2.2 Economic
equilibrium
• agents inelastically supply total labor endowment L̄(t )
2.4 Dynamic • labor market clearing condition:
equations
2.5 Steady state
2.6 Transitional
L(t ) = L̄(t )
dynamics
3 Solow model • Assumption 1 and competitive labor markets guarantee

with growth
3.1 Balanced growth w (t ) > 0
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
44 / 76
Econ 2110:
Chapter 1
Hanley Economic equilibrium

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
• Capital market:
2 Basic Solow
model
• agents own the capital stock of the economy and rent it to
2.1 Economic firms
• initial capital holdings K (0)
environment
2.2 Economic
equilibrium
• capital market clearing condition:
2.4 Dynamic
equations
K s (t ) = K d (t )
2.5 Steady state
2.6 Transitional
dynamics • rental price of capital is R (t )
3 Solow model • capital depreciates at rate δ
with growth
3.1 Balanced growth
• interest rate faced by agents is r (t ) = R (t ) − δ
3.2 Technological
change
3.3 Dynamics
• Price of final good is P (t ) → normalized to one in all
4 Solow model in periods
continuous time
4.1 Steady State
4.2 Examples
45 / 76
Econ 2110:
Chapter 1
Hanley Firm optimization

1 Long-run facts • Problem of a representative firm
1.1 Growth facts
1.2 Kaldor facts
max F [K (t ), L(t ), A(t )] − w (t )L(t ) − R (t )K (t )
2 Basic Solow L(t )≥0, K (t )≥0
model
2.1 Economic
environment • Factor pricing equations, marginal products
2.2 Economic
equilibrium
2.3 Firm optimization w (t ) = FL [K (t ), L(t ), A(t )]
2.4 Dynamic
equations R (t ) = FK [K (t ), L(t ), A(t )]
2.5 Steady state
2.6 Transitional
dynamics • Proposition 2.1. Zero profits for firms
3 Solow model
with growth
Suppose Assumption 1 holds. Then in the equilibrium of the
3.1 Balanced growth Solow growth model, firms make no profits, and in
3.2 Technological
change particular,
3.3 Dynamics
Y (t ) = w (t )L(t ) + R (t )K (t )
4 Solow model in
continuous time
4.1 Steady State
Proof: Follows from Euler Theorem for the case of m = 1,
4.2 Examples i.e., constant returns to scale.
46 / 76
Econ 2110:
Chapter 1
Hanley Firm optimization

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model • Assumption 2. Inada conditions
2.1 Economic
environment A function F satisfies the Inada conditions if
2.2 Economic
equilibrium
2.3 Firm optimization lim FK (·) = ∞ and lim FK (·) = 0 for all L > 0
2.4 Dynamic K →0 K →∞
equations
2.5 Steady state lim FL (·) = ∞ and lim FL (·) = 0 for all K > 0
2.6 Transitional
L→0 L→ ∞
dynamics
3 Solow model
with growth
Moreover, F (0, L, A) = F (K , 0, A) = 0 for all K and L.
3.1 Balanced growth • Assumption 2 is useful for existence of interior equilibrium
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
47 / 76
Econ 2110:
Chapter 1
Hanley Dynamic equations

1 Long-run facts
1.1 Growth facts
• Law of motion capital stock
1.2 Kaldor facts
2 Basic Solow
model K (t + 1) = (1 − δ )K (t ) + I (t )
2.1 Economic
environment
2.2 Economic
equilibrium
• National income accounting
2.4 Dynamic
equations Y (t ) = C (t ) + I (t )
2.5 Steady state
• Fundamental dynamic equation of Solow model

2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
I (t ) = sY (t )
3.2 Technological
change ↓
K (t + 1) = sF [K (t ), L(t ), A(t )] + (1 − δ)K (t )
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
48 / 76
Econ 2110:
Chapter 1

1 Long-run facts
1.1 Growth facts
• Temporary assumptions:
1.2 Kaldor facts
2 Basic Solow
model
• no population growth: L(t ) = L > 0
2.1 Economic
environment • no technological progress: A(t ) = A
2.2 Economic
equilibrium
2.3 Firm optimization • Definition 2.2. Equilibrium in Solow model
2.4 Dynamic
equations For given L, A, and K (0), an equilibrium path is a sequence
2.5 Steady state
2.6 Transitional
{K (t ), Y (t ), C (t ), w (t ), R (t )}t∞=0 such that:
dynamics
3 Solow model
• K (t ) satisfies the capital evolution equation
with growth • Y (t ) is given by the production function
3.1 Balanced growth
• C (t ) satisfies the agent’s consumption equation
3.2 Technological
change • w (t ) and R (t ) satisfy the factor pricing equations
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
49 / 76
Econ 2110:
Chapter 1

1 Long-run facts • Capital-labor ratio:
1.1 Growth facts
1.2 Kaldor facts K (t )
2 Basic Solow
k (t ) ≡
model L
2.1 Economic
environment • Output (income) per capita:
2.2 Economic
equilibrium [ ]
Y (t ) K (t )
y (t ) ≡ , 1, A ≡ f (k (t ))
2.4 Dynamic =F
equations L L
2.5 Steady state
2.6 Transitional
dynamics • From Euler Theorem:
3 Solow model
with growth R (t ) = f ′ (k (t )) > 0 and
3.1 Balanced growth
3.2 Technological
change
w (t ) = f (k (t )) − k (t )f ′ (k (t )) > 0
3.3 Dynamics
4 Solow model in • Per capita dynamic equation:

continuous time
4.1 Steady State
4.2 Examples
k (t + 1) = sf (k (t )) + (1 − δ)k (t )
50 / 76
Econ 2110:
Chapter 1
Hanley Steady state

1 Long-run facts • Definition 2.3. Steady-state equilibrium
1.1 Growth facts A steady-state equilibrium without technological progress
1.2 Kaldor facts
2 Basic Solow
and population growth is an equilibrium path in which
model k (t ) = k ∗ for all t.
• Here k ∗ satisfies
2.1 Economic
environment
sf (k ∗ ) = δk ∗
2.2 Economic
equilibrium
2.4 Dynamic
equations
• Proposition 2.2. Existence of steady state equilibrium
2.5 Steady state Under Assumptions 1 and 2, there exists a unique steady
2.6 Transitional
dynamics state equilibrium in the Solow model where the capital-labor
3 Solow model
with growth ratio k ∗ ∈ (0, ∞) satisfies sf (k ∗ ) = δk ∗ ; per capita output
3.1 Balanced growth is given by
3.2 Technological
change y ∗ = f (k ∗ )
3.3 Dynamics
4 Solow model in and per capita consumption is given by

continuous time
4.1 Steady State
4.2 Examples
c ∗ = (1 − s )f (k ∗ )
51 / 76
Econ 2110:
Chapter 1
Hanley Steady state

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
• Proposition 2.3. Comparative statics Solow model
model Suppose Assumptions 1 and 2 hold and f (k ) = Af˜(k ).
2.1 Economic
environment Denote the steady-state level of the capital-labor ratio by
2.2 Economic
equilibrium k ∗ (A, s, δ) and the steady-state level of output by
2.4 Dynamic
y ∗ (A, s, δ) when the underlying parameters are A, s and δ.
equations
2.5 Steady state
Then we have
∂k ∗ (·) ∂k ∗ (·) ∂k ∗ (·)
2.6 Transitional
dynamics
> 0, > 0 and <0
∂A ∂s ∂δ
3 Solow model
with growth
3.1 Balanced growth ∂y ∗ (·) ∂y ∗ (·) ∂y ∗ (·)
3.2 Technological > 0, > 0 and < 0.
change ∂A ∂s ∂δ
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
52 / 76
Econ 2110:
Chapter 1
Hanley Steady state

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow • Comparative statics for c ∗ ?

model
c ∗ (s ) = (1 − s )f (k ∗ (s )) = f (k ∗ (s )) − δk ∗ (s )
2.1 Economic
environment
2.2 Economic
equilibrium
2.4 Dynamic
and differentiating with respect to s,
equations
2.5 Steady state
∂c ∗ (s ) [ ] ∂k ∗
2.6 Transitional = f ′ (k ∗ (s )) − δ
dynamics
∂s ∂s
3 Solow model
• Golden rule → sgold is such that ∂c ∗ (sgold )/∂s = 0, so kgold

∗
with growth
3.1 Balanced growth
3.2 Technological
change
is such that f ′ (kgold
∗ )=δ
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
53 / 76
Econ 2110:
Chapter 1
Hanley Transitional dynamics

1 Long-run facts • Question: given k (0) > 0, how does the economy behave
1.1 Growth facts
along the transition path and does it tend to the steady
1.2 Kaldor facts
2 Basic Solow
state?
model
• Solow model → nonlinear difference equation
2.1 Economic
• Math refresh 1. Linear autonomous difference equations

environment
2.2 Economic
equilibrium
2.4 Dynamic x (t + 1) = mx (t ) + b
equations
2.5 Steady state
2.6 Transitional
dynamics
• steady state: x ∗ = b/(1 − m )
3 Solow model • general solution:
with growth
x g (t ) = dmt + x ∗
3.1 Balanced growth
3.2 Technological
change
• solution associated with boundary condition x (0) = x0 is
3.3 Dynamics
4 Solow model in x ( t ) = ( x0 − x ∗ ) m t + x ∗
continuous time
4.1 Steady State • global asymptotically stability → x (t ) → x ∗ if |m | < 1
4.2 Examples
54 / 76
Econ 2110:
Chapter 1

1 Long-run facts • Math refresh 2. Nonlinear autonomous difference
1.1 Growth facts
1.2 Kaldor facts
equations
2 Basic Solow x (t + 1) = g (x (t ))
model
2.1 Economic
environment • steady state: x ∗ = g (x ∗ )
2.2 Economic
equilibrium
• assume g is differentiable around x ∗
2.3 Firm optimization • study local dynamics using
2.4 Dynamic
equations
2.5 Steady state x (t + 1) ≃ x ∗ + g ′ (x ∗ )(x (t ) − x ∗ )
2.6 Transitional
dynamics
3 Solow model
• x ∗ is locally asymptotically stable if |g ′ (x ∗ )| < 1
with growth • if |g ′ (x )| < 1 for all x ∈ R, then x ∗ is globally
3.1 Balanced growth
asymptotically stable
3.2 Technological
change
3.3 Dynamics • Solow dynamic equation discrete time
4 Solow model in
continuous time
4.1 Steady State k (t + 1) = sf (k (t )) + (1 − δ)k (t ) ≡ g (k (t ))
4.2 Examples
55 / 76
Econ 2110:
Chapter 1

1 Long-run facts
1.1 Growth facts • Proposition 2.5. Global asymptotic stability in Solow
1.2 Kaldor facts
model
2 Basic Solow
model Suppose that Assumptions 1 and 2 hold, then the
2.1 Economic
environment steady-state equilibrium of the Solow growth model k ∗ is
2.2 Economic
equilibrium
globally asymptotically stable, and starting from any
2.3 Firm optimization k (0) > 0, {k (t )}t∞=0 monotonically converges to k ∗ .
2.4 Dynamic
equations Sketch of proof:
2.5 Steady state
2.6 Transitional
dynamics
• local stability:
g ′ (k ∗ ) = sf ′ (k ∗ ) + (1 − δ) < 1
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change because by concavity
3.3 Dynamics
4 Solow model in δ = sf (k ∗ )/k ∗ > sf ′ (k ∗ )

continuous time
4.1 Steady State
4.2 Examples
56 / 76
Econ 2110:
Chapter 1

1 Long-run facts
1.1 Growth facts • Proposition 2.5. Global asymptotic stability in Solow
1.2 Kaldor facts
2 Basic Solow
model
model Sketch of proof:
2.1 Economic
environment
• global stability:
2.2 Economic
• for all k (t ) ∈ (0, k ∗ )
equilibrium
2.4 Dynamic
equations
∫ k∗
2.5 Steady state k (t + 1) − k ∗ = g (k (t )) − g (k ∗ ) = − g ′ (k )dk < 0
2.6 Transitional
k (t )
dynamics
3 Solow model • since f (k )/k is decreasing in k

with growth
3.1 Balanced growth k (t + 1) − k (t ) f (k (t )) f (k ∗ )
=s −δ > s ∗ −δ = 0
3.2 Technological
change k (t ) k (t ) k
3.3 Dynamics
4 Solow model in
• thus for all k (t ) ∈ (0, k ∗ ), k (t + 1) ∈ (k (t ), k ∗ )
continuous time
4.1 Steady State
4.2 Examples
57 / 76
Econ 2110:
Chapter 1

1 Long-run facts • Questions:
1.1 Growth facts
1.2 Kaldor facts • half life: how many periods does it take to cover half the
2 Basic Solow distance between k (t ) and k ∗ ?
model
• speed of convergence: how fast does k (t ) approach k ∗ ?
2.1 Economic
environment
2.2 Economic
equilibrium
• Use local dynamics to approximate
• first-order Taylor expansion
2.4 Dynamic
equations
2.5 Steady state
k (t + 1) − k ∗ ≃ g ′ (k ∗ )(k (t ) − k ∗ )
2.6 Transitional
dynamics
3 Solow model • measure of speed of convergence is 1 − g ′ (k ∗ ) with:

with growth
[ ]
3.1 Balanced growth
′ ∗f ′ (k ∗ )k ∗ f ′ (k ∗ )k ∗
3.2 Technological
g (k ) = + (1 − δ ) 1 −
change
3.3 Dynamics
f (k ∗ ) f (k ∗ )
4 Solow model in
continuous time • half-life:
∗
4.1 Steady State g ′ (k ∗ )t = 0.5
4.2 Examples
58 / 76
Econ 2110:
Chapter 1
Hanley
1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic
equilibrium
Solow model with growth
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
59 / 76
Econ 2110:
Chapter 1
Hanley Balanced growth

1 Long-run facts • Basic Solow model has no growth, except when the
1.1 Growth facts economy starts with k (0) < k ∗
1.2 Kaldor facts
2 Basic Solow • Change assumptions:

model
2.1 Economic
• population growth: L(t + 1) = (1 + n )L(t )
environment
• technology growth: A(t + 1) = (1 + g )A(t )
2.2 Economic
equilibrium
2.3 Firm optimization • General production function:
2.4 Dynamic
equations
2.5 Steady state Y (t ) = F [K (t ), L(t ), A(t )]
2.6 Transitional
dynamics
3 Solow model • Does it admit a balanced growth path (BGP)?

with growth
3.1 Balanced growth
3.2 Technological
Y (t ) = Y (0)(1 + gY )t
change
3.3 Dynamics C (t ) = C (0)(1 + gC )t
4 Solow model in
continuous time
K (t ) = K (0)(1 + gK )t
4.1 Steady State
I (t ) = I (0)(1 + gI )t
4.2 Examples
60 / 76
Econ 2110:
Chapter 1
Hanley Balanced growth

1 Long-run facts • Tasks:
1.1 Growth facts
1.2 Kaldor facts • find growth rate of each variable along the BGP
2 Basic Solow • verify whether such path is technologically feasible
model
2.1 Economic
environment • Finding balanced growth:
2.2 Economic
equilibrium 1 from capital accumulation equation
K (t + 1) = (1 − δ )K (t ) + I (t )
2.4 Dynamic
equations
2.5 Steady state
2.6 Transitional
dynamics it must be gK = gI
3 Solow model 2 from national accounts
with growth
3.1 Balanced growth
3.2 Technological
C (t ) + I (t ) = Y (t )
change
3.3 Dynamics
it must be gC = gI = gY
4 Solow model in
continuous time 3 is production function consistent with gY = gK ? and what
4.1 Steady State is gY ?
4.2 Examples
61 / 76
Econ 2110:
Chapter 1
Hanley Technological change

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts • Types of technological change for some constant returns to
2 Basic Solow
model
scale function F̃ :
2.1 Economic
environment
• Hicks-neutral:
2.2 Economic
equilibrium
F̃ [K (t ), L(t ), A(t )] = A(t )F [K (t ), L(t )]
2.4 Dynamic
equations
• Solow-neutral:
2.5 Steady state
2.6 Transitional
dynamics
F̃ [K (t ), L(t ), A(t )] = F [A(t )K (t ), L(t )]
3 Solow model
with growth
3.1 Balanced growth
• Harrod-neutral:
3.2 Technological
change
3.3 Dynamics
F̃ [K (t ), L(t ), A(t )] = F [K (t ), A(t )L(t )]
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
62 / 76
Econ 2110:
Chapter 1

1 Long-run facts • It is common in macro to assume Harrod-neutral
1.1 Growth facts
1.2 Kaldor facts
technological change
2 Basic Solow
model
Y (t ) = F [K (t ), A(t )L(t )]
2.1 Economic
environment
2.2 Economic
equilibrium • Why?
2.4 Dynamic • since function is constant returns to scale in capital K (t )
equations
2.5 Steady state
and effective labor A(t )L(t ):
2.6 Transitional
dynamics
( )
Y (t ) K (t )
3 Solow model =F ,1
with growth A(t )L(t ) A(t )L(t )
3.1 Balanced growth
3.2 Technological • BGP is technologically feasible for any constant returns to
change
3.3 Dynamics scale function F and
4 Solow model in
continuous time 1 + gK = 1 + gY = (1 + n )(1 + g )
4.1 Steady State
4.2 Examples
63 / 76
Econ 2110:
Chapter 1

1 Long-run facts
1.1 Growth facts
• Consider all types of technological change together

1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
C (t ) + q (t )I (t ) = Z (t )F [B̃ (t )K (t ), Ã(t )L(t )]
2.2 Economic
equilibrium
2.3 Firm optimization where:
2.4 Dynamic
equations 1 q (t + 1) = (1 + gq )q (t ) with gq < 0
2.5 Steady state
2.6 Transitional
2 Z (t + 1) = (1 + gZ )Z (t ) with gZ > 0
dynamics
3 B̃ (t + 1) = (1 + gB )B̃ (t ) with gB > 0
3 Solow model
with growth 4 Ã(t + 1) = (1 + g )Ã(t ) with g > 0
3.1 Balanced growth
3.2 Technological • Under the assumption of constant returns to scale Z is
change
3.3 Dynamics redundant
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
64 / 76
Econ 2110:
Chapter 1

1 Long-run facts
• Proposition. Cobb-Douglas production and BGP
1.1 Growth facts
1.2 Kaldor facts If F is a Cobb-Douglas production function of the type
2 Basic Solow
Y (t ) = (B (t )K (t ))α (A(t )L(t ))1−α

model
2.1 Economic
environment
2.2 Economic
equilibrium then we can have gq < 0, gZ > 0, gB > 0 and g > 0
2.4 Dynamic
without invalidating a balanced growth path as a solution.
equations
2.5 Steady state
Proof:
2.6 Transitional
dynamics
b(t ) := B (t )α/(1−α) A(t ) and write
• define A
3 Solow model
with growth
C (t ) + q (t )I (t ) = K (t )α (Ab(t )L(t ))1−α
3.1 Balanced growth
3.2 Technological
change b (t ) := q (t )K (t ) and Ib(t ) := q (t )I (t ) to write
• define K
3.3 Dynamics
Kb (t + 1) = (1 − δ)(1 + gq )Kb (t ) + (1 + gq )Ib(t )

4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
65 / 76
Econ 2110:
Chapter 1

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic • Proposition. Cobb-Douglas production and BGP
environment
2.2 Economic Proof:
equilibrium
2.3 Firm optimization b(t ) := (B (t )/q (t ))α/(1−α) A(t ) and write new
• redefine A
2.4 Dynamic
equations model
2.5 Steady state
C (t ) + Ib(t ) = (Kb (t ))α (Ab(t )L(t ))1−α
2.6 Transitional
dynamics
3 Solow model Kb (t + 1) = (1 − δ)(1 + gq )Kb (t ) + (1 + gq )Ib(t )

with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
66 / 76
Econ 2110:
Chapter 1
Hanley Dynamics
1 Long-run facts • Assume production function of the type
1.1 Growth facts
1.2 Kaldor facts Y (t ) = F [K (t ), A(t )L(t )]
2 Basic Solow
model • Define effective capital-labor ratio:
2.1 Economic
environment
K (t )
2.2 Economic
equilibrium k (t ) ≡
2.3 Firm optimization A(t )L(t )
2.4 Dynamic
equations
• Output per-effective unit of labor:
( )
2.5 Steady state
2.6 Transitional
dynamics Y (t ) K (t )
3 Solow model
yb(t ) = =F ,1 ≡ f (k (t ))
with growth A(t )L(t ) A(t )L(t )
• Along BGP yb(t ) and k (t ) are constant, but there is growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics in per-capita income (output) y (t )
4 Solow model in • Key dynamic equation
continuous time
4.1 Steady State
4.2 Examples
(1 + n)(1 + g )k (t + 1) = (1 − δ)k (t ) + sf (k (t ))
67 / 76
Econ 2110:
Chapter 1
Hanley Dynamics
1 Long-run facts • Steady state k ∗ is
1.1 Growth facts
1.2 Kaldor facts [(1 + n)(1 + g ) − (1 − δ)] k ∗ = sf (k ∗ )
2 Basic Solow
• Local stability:
model
2.1 Economic
environment
2.2 Economic
• dynamic equation:
equilibrium
(1 − δ)k (t ) + sf (k (t ))
2.4 Dynamic k (t + 1) = := g (k (t ))
equations (1 + n)(1 + g )
2.5 Steady state
2.6 Transitional
dynamics • Taylor expansion
≃ k ∗ + g ′ (k ∗ )(k (t ) − k ∗ )
3 Solow model
with growth k (t + 1)
3.1 Balanced growth
(1 − δ) + sf ′ (k ∗ )
3.2 Technological
change
≃ k∗ + (k (t ) − k ∗ )
3.3 Dynamics
(1 + n)(1 + g )
4 Solow model in
continuous time • g ′ (k ∗ ) > 0
4.1 Steady State • g ′ (k ∗ ) < 1 because g (k (t )) is concave and g (k ∗ )/k ∗ = 1
4.2 Examples
68 / 76
Econ 2110:
Chapter 1
Hanley
1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
2.1 Economic
environment
2.2 Economic Solow model in continuous
equilibrium
2.4 Dynamic
time
equations
2.5 Steady state
2.6 Transitional
dynamics
3 Solow model
with growth
3.1 Balanced growth
3.2 Technological
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
69 / 76
Econ 2110:
Chapter 1
Hanley Steady State

1 Long-run facts • Population and technology growth:
1.1 Growth facts • population: L(t ) = exp(nt )L(0) or
1.2 Kaldor facts
2 Basic Solow L̇(t )

model =n
2.1 Economic L(t )
environment
2.2 Economic
equilibrium • technology: A(t ) = exp(gt )A(0) or
2.4 Dynamic Ȧ(t )
equations =g
2.5 Steady state A(t )
2.6 Transitional
• Continuous-time law of motion

dynamics
3 Solow model
with growth
3.1 Balanced growth K̇ (t ) = sF [K (t ), A(t )L(t )] − δK (t )
3.2 Technological
change
3.3 Dynamics • Capital in effective units of workers
4 Solow model in
continuous time k̇ (t ) sf (k (t ))
4.1 Steady State
= − (δ + g + n)
4.2 Examples
k (t ) k (t )
70 / 76
Econ 2110:
Chapter 1
Hanley Steady State

1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
model
• Proposition 2.11. Steady state Solow model in continuous
2.1 Economic
environment
time
2.2 Economic
equilibrium
Suppose Assumptions 1 and 2 hold. There exists a unique
2.3 Firm optimization steady state equilibrium where the effective capital-labor
2.4 Dynamic
equations ratio is equal to k ∗ ∈ (0, ∞) and is given by
2.5 Steady state
2.6 Transitional
dynamics f (k ∗ ) δ+g +n
=
3 Solow model
with growth
k∗ s
3.1 Balanced growth
3.2 Technological
Per capita output and consumption grow at the rate g .
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
71 / 76
Econ 2110:
Chapter 1
Hanley Steady State

1 Long-run facts
• Question: given k (0) > 0, how does the economy behave
1.1 Growth facts along the transition path and does it tend to the steady
1.2 Kaldor facts
state?
• Solow model in continuous time → nonlinear differential
2 Basic Solow
model
2.1 Economic
environment equation
2.2 Economic
equilibrium
• Math refresh 3. Linear autonomous differential equations
2.4 Dynamic ẋ (t ) = mx (t ) + b
equations
2.5 Steady state
• steady state: x ∗ = −b/m
2.6 Transitional
dynamics • general solution:
3 Solow model
with growth b
x g (t ) = − + d exp(mt )
3.1 Balanced growth m
3.2 Technological
change • solution associated with boundary condition x (0) = x0 is
3.3 Dynamics
b b
4 Solow model in
continuous time x (t ) = − + (x0 + ) exp(mt )
m m
4.1 Steady State
4.2 Examples • global asymptotically stability → x (t ) → x ∗ if m < 0
72 / 76
Econ 2110:
Chapter 1
Hanley Steady State

1 Long-run facts • Math refresh 4. Nonlinear autonomous differential
1.1 Growth facts
1.2 Kaldor facts
equations
2 Basic Solow ẋ (t ) = g (x (t ))
model
2.1 Economic
environment • steady state: g (x ∗ ) = 0
2.2 Economic
equilibrium
• assume g is differentiable around x ∗
2.3 Firm optimization • study local dynamics using
2.4 Dynamic
equations
2.5 Steady state ẋ (t ) ≃ g ′ (x ∗ )(x (t ) − x ∗ )
2.6 Transitional
dynamics
3 Solow model
• x ∗ is locally asymptotically stable if g ′ (x ∗ ) < 0
with growth • if g (x (t )) < 0 for all x (t ) > x ∗ and g (x (t )) > 0 for all
3.1 Balanced growth
x (t ) < x ∗ , then x ∗ is globally asymptotically stable
3.2 Technological
change
3.3 Dynamics • Solow dynamic equation continuous time
4 Solow model in
continuous time
4.1 Steady State k̇ (t ) = sf (k (t )) − (δ + g + n )k (t ) ≡ g (k (t ))
4.2 Examples
73 / 76
Econ 2110:
Chapter 1
Hanley Steady State

1 Long-run facts
• Proposition 2.13. Global stability Solow model continuous
1.1 Growth facts time
1.2 Kaldor facts
Suppose Assumptions 1 and 2 hold, then the Solow growth
2 Basic Solow
model model in continuous time is asymptotically stable, i.e.,
2.1 Economic
environment starting from any k (0) > 0, the effective capital-labor ratio
2.2 Economic
equilibrium converges to a steady-state value k ∗ or k (t ) → k ∗ .
• Cobb-Douglas example →
2.4 Dynamic
equations
• dynamic equation:
2.5 Steady state
k̇ (t ) = sk (t )α − (δ + g + n)k (t )
2.6 Transitional
dynamics
3 Solow model
with growth • change of variable: x (t ) ≡ k (t )1−α
3.1 Balanced growth
3.2 Technological ẋ (t ) = (1 − α)s − (1 − α)(δ + g + n )x (t )
change
3.3 Dynamics
with solution
4 Solow model in [ ]
continuous time s s
x (t ) = + x (0) − exp(−(1 − α)(δ + g +
4.1 Steady State
δ+g +n δ+g +n
4.2 Examples
74 / 76
Econ 2110:
Chapter 1
Hanley Examples
1 Long-run facts
1.1 Growth facts
• Cobb-Douglas example →
1.2 Kaldor facts
2 Basic Solow
model
• solution
2.1 Economic
environment
s
2.2 Economic k (t )1− α =
equilibrium
δ+g +n
2.3 Firm optimization [ ]
s
+ k (0)1− α −
2.4 Dynamic
equations exp(−(1 − α)(δ + g + n )t )
2.5 Steady state δ+g +n
2.6 Transitional
dynamics
• starting from any k (0),
3 Solow model
with growth k (t ) → k ∗ = (s/(δ + g + n ))1/(1−α)
3.1 Balanced growth
• gap between k (0) and k ∗ closed at the exponential rate
3.2 Technological
change (1 − α)(δ + g + n)
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
75 / 76
Econ 2110:
Chapter 1
Hanley Examples
1 Long-run facts
1.1 Growth facts
1.2 Kaldor facts
2 Basic Solow
• Solow model as workhorse of modern macro:
model
2.1 Economic
1 Growth:
environment
2.2 Economic • exogenous growth: F (K (t ), L, A(t )) = A(t )K (t )α L1−α with
equilibrium
A(t ) growing at rate g
2.4 Dynamic
• simplest endogenous growth → F (K (t )) = AK (t )
equations
2.5 Steady state 2 Business cycles:
2.6 Transitional
dynamics
• A(t ) is stochastic
3 Solow model • example → two values: AL and AH
with growth
3.1 Balanced growth
• ergodic set [K L , K H ]
3.2 Technological • stationarity
change
3.3 Dynamics
4 Solow model in
continuous time
4.1 Steady State
4.2 Examples
76 / 76

Macro Solow

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Macro Solow

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Econ 2110:

3 Solow model University of Pittsburgh

Hanley Growth facts

3 Solow model Country Income 1820 * Income 1913

Hanley Growth facts

Hanley Growth facts

Hanley Growth facts

Hanley Growth facts

2.2 Economic 1980

2.3 Firm optimization

2.5 Steady state

3.1 Balanced growth

Hanley Growth facts

Source: Penn World Tables (8.1) 8 / 76

Hanley Growth facts

Hanley Growth facts

Hanley Growth facts

Hanley Growth facts

Hanley Growth facts

equilibrium FIN IRL BEL PRT NZL DNK

3 Solow model 1.0 0.5 0.0 0.50 0.25 0.00 0.25

Hanley Growth facts

Hanley Growth facts

Hanley Growth facts

Hanley Growth facts

Hanley Growth facts

Hanley Growth facts

Hanley Growth facts

Hanley Growth facts

Hanley Growth facts

Hanley Growth facts

Hanley Kaldor facts

Hanley Kaldor facts

Hanley Kaldor facts

Hanley Kaldor facts

Hanley Kaldor facts

Hanley Kaldor facts

Hanley Kaldor facts

Hanley Kaldor facts

3 Solow model investment

Hanley Kaldor facts

Hanley Kaldor facts

Hanley Kaldor facts

Hanley Kaldor facts

Hanley Kaldor facts

Hanley Kaldor facts

4 Solow model in 1950 1960 1970 1980 1990 2000 2010

Hanley Kaldor facts

4 Solow model in 1950 1960 1970 1980 1990 2000 2010

Basic Solow model

Hanley Economic environment

Hanley Economic environment

3 Solow model • aggregate production function for final good is

Hanley Economic environment

2 Basic Solow • Assumption 1. Properties of the production function

Hanley Economic environment

x ∈ R and y ∈ R, with partial derivatives denoted by gx

Hanley Economic equilibrium

3 Solow model • Assumption 1 and competitive labor markets guarantee

Hanley Economic equilibrium

Hanley Firm optimization

Hanley Firm optimization

Hanley Dynamic equations

• Fundamental dynamic equation of Solow model