Uses of Solow model of economic growth
The Solow model (Solow Model) used for the analysis of industrial structure, rarely reported in the literature, this paper attempts an analysis of the Solow model to propose a framework for the analysis of industrial structure, and China’s overall and the eastern, central and western regions structure analysis.
Solow (Solow) growth of the neoclassical economic theory suggests that economic growth per capita by an efficient capital stock (capital stock per effective worker) growth of production; efficient steady-state per capita capital stock will appear (steady state).
In the steady state as long as the savings rate remains unchanged, an efficient fixed per capita output will no longer change, at this time per capita economic growth rate is equal to the rate of technological progress.
The basic model is as follows: Production functions satisfy constant returns to scale (constant returns to scale), the elements of diminishing marginal product. For the amount of labour input L (t), the amount of capital Investment K (t), labour efficiency (efficiency of worker, E (t)) and growth rate of (labour-augmenting technological progress, g) of the production function.
The exogenous growth model of Robert Solow and others places emphasis on the role of technological change. Unlike the Harrod-Domar model, the saving rate will only determine the level of income but not the rate of growth. The sources-of-growth measurement obtained from this model highlights the relative importance of capital accumulation (as in the Harrod-
Domar model) and technological change (as in the Neoclassical model) in economic growth. The original Solow study showed that technological change accounted for almost 90 per cent of U.S. economic growth in the late 19th and early 20th centuries. Empirical studies on developing countries have shown different results.
However, when looking at the growth rate put forward from the neoclassical growth model, it seems to suggest that countries with same characteristics and technology will eventually converge to the same rate of growth.
However, one should know that the knowledge presented in countries that promotes technological advancement is not stationary. Meaning that knowledge are linked to individual and not to the country.
The equation takes its name from a synthesis of analysis of growth by the British economist Sir Roy F. Harrod and the Polish-American economist Evsey Domar.
The Harrod-Domar model in the early postwar times was commonly used by developing countries in economic planning. With a target growth rate, and information on the capital-output ratio, the required saving rate can be calculated.
The Harrod-Domar model explains how the income of today affects the income of tomorrow in a simple equation where the data entries are minimal. Although the Harrod-Domar model is easy to use, there are a few limitations.
The economy only enters equilibrium when there is a full employment of both labour and capital. Using the fixed-coefficient production function, the capital-labour ratio must remain constant.
On a graph, with capital on the y-axis and labour on the x-axis, we can illustrate all the different combinations of capital and labour that equal the same income through L-shaped isoquants.
In order to be at full employment, capital and labour must grow at the same rate, which is unlikely. First, capital stock must grow at the same rate as output, which implies constant growth at full employment of capital. The capital stock to output ratio (v) is capital stock divided by output, where the variables grow at the same rate.
Output grows at a rate of g; therefore, capital stock must be growing at the same rate. If we apply the above logic to labour, the population must be growing at same growth rate, g. Now what if the labour force is growing too fast, where n
With increasing returns to scale, diminishing returns to capital do not necessarily set in. With varying combinations of labour and capital, the isoquants are curved in the Solow model. The first piece of Solow’s change involved the production function; it is no longer a straight line because it takes into account diminishing marginal productivity.
Growth rates do not slow or plateau, implying the economy does not reach a steady state; therefore, continued growth in countries can be explained without the variable technological change, present in the Solow model.
For example, Henry Ford’s development of the production line system, not only created benefits for Ford Motor Company, but also opened a door for the entire economy.
Solow’s model assumes a constant return to scale, although the national economy is subject to increasing returns to scale. In the Harrod- Domar model, the savings rate (s), the growth rate of the population (n), and the capital-output ratio (v) were taken as constants or exogenous variables.
The second piece of Solow’s change is the accumulation of capital. The impact of capital, labour, and technological advances will have a greater impact on the economy than Solow’s model suggests.
For example, by doubling capital, labour, and other factors of production, we are able to more than double output.
Solow used his knowledge of the problems involved in the Harrod-Domar model, and replaced the fixed- coefficients production function with a neoclassical production function that allowed flexibility and substitution between capital and labour.
Solow understood that all these variables were capable of changing from time to time, but sporadically and more or less independently.
There are new workers, but the machinery is not being used, which implies labour unemployment. Regardless of the implications in the Solow model, it still “represents the vast majority of variation in economic growth across countries”.