Examine and Explain the Main Aspects of the Solow-Growth Model

Name: Cameron Byrne

Tutor:  Nandipa Fumbabta

Tutor Period: Fridays, Period 1

Student Number: g13b2866

ECONOMICS 202 ASSIGNMENT

Due date: 14 April, 2014

TOPIC: Examine and explain the main aspects of the Solow-growth model of economic growth AND identify whether capital accumulation has been the main cause for economic growth in South Africa.  Discuss the main strengths and weaknesses of this model and how it can be improved in order to provide a better fit for South Africa?

Abstract:[pic 1]

Word Count: 1685

Table of Contents:

1: Introduction……………………………………………………………………....pg3

2: Main aspects of the Solow Growth model…………………………………..…..pg4,5,6

- Assumptions

- Model- steady state, golden rule, convergence hypothesis

- General conclusions from the model

3: Capital Accumulation a main drive of economic growth in South Africa?…...pg7

4: Discussion on Strengths and Weakness of the model……………………………pg8

5: How the Solow Growth model can be improved………………………………....pg9

-Constant Technology

-No Diminishing Marginal Productivity

-Augmented Solow Growth Model (include capital)

6: Conclusion………………………………………………………………………..…pg10

List of References

1: Introduction

The Solow growth model is an exogenous model that has the goal of deepening our understanding of economic growth by adding a theory of capital accumulation to the production model. The Solow growth model has the objective of providing us with a solid theory of sustained long-run economic growth. This essay will determine whether or not it truly does or does not provide us with a solid theory. Looking at all the main aspects, capital accumulation, strengths/weaknesses and how the model can be improved will give information that will hopefully help prove whether the model does or does not have a solid theory of sustained long-run economic growth.

2: Main aspects of the Solow growth model

General assumptions and main aspects of the model are that there are diminishing returns to capital or labour, referring to the law of diminishing returns. The law of diminishing returns states that as more and more capital is brought into the production process with the amount of hours worked staying the same, each new piece of equipment/human capital is allocated less of workers time, the increases in output become smaller and smaller (Burda and Wyplosz, 2013: 58).

In looking at the main aspects of the Solow growth model constant returns to scale is an important aspect. Output increases when either inputs of capital or labour increases (Burda and Wyplosz, 2013: 58). When inputs of capital and labour are let’s say both doubled (increased by their full potential) and output ends up being doubled as a result it is said to have constant returns to scale. However if a doubling of inputs ends up to be more than the doubling of output then it is said to have increasing returns to scale and vice versa for decreasing returns.

The Solow growth model needs a constant savings rate, constant depreciation rate and will only work if in a closed economy. According to Suri (2012) a closed economy is an economy which doesn’t have any relation with rest of the world it is instead confined to itself. No exports and imports to and from foreign countries take place.  

The steady state is an unvarying condition which basically means that it is a stable condition that doesn’t change over time, it is characterised by constancy in certain key macroeconomic variables. At point A on the diagram below, the depreciation line equals the savings line this is where utility is maximised and where the steady state occurs. It is important to note that at K below the steady state investment is greater than depreciation which means the capital stock increases as people need to save more. At K above the steady state investment is less than depreciation and the capital stock decreases as people are not saving enough.