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Economic Modeling (Neo-classical)

Page history last edited by editor 7 years, 2 months ago

 

 

 Harrod-Domar Model

Brief Description

The model describes economy’s growth rate in terms of the level of saving and productivity of capital.

 

Model

Set-up

Production Function:

Y = F(K) = K/ ɵ

 

Evolution of Capital Stock:

dk/dt = sY(t) – δK(t)

 

 

Economy’s Growth rate:

g = s/ɵ  -  δ

 

Assumption:

  1.  A closed economy
  2.  Fixed population
  3.  A fixed amount of capital is required for each unit of output

 

Endogenous:

Y = output (and income)

K = capital stock (or K(t))

 

Exogenous:

s = savings rate

δ = depreciation

ɵ = fixed coefficient production

 

Implications

  • ·         Accumulation of savings (s) à economic growth increases (g)
  • ·         Higher capital required to produce each unit of output (ɵ) à economic growth decreases (g)
  • ·         Higher depreciation (δ) à economic growth decreases (g)

 

Limitations/Criticisms

Example

  • ·        
  • ·         Marginal product of capital is not diminishing, which means the model assumes that the capital can accumulate forever
  • ·         Savings rate might not be exogenous given it depends on the overall income of the population
  • Performance of early Soviety Union conformed to the Model, but later became stagnant
  • Model inspired aid for large infrastructure projects; which seemed to have disappointingly little effect (But it depends on level of aid) as per some critics such as Easterly

 

 

 

Solow Model

Brief Description

Solow Model is neoclassical growth model that tries to explain long run economic growth by looking at productivity, capital accumulation and population growth.

Model

Set-up

Production Function:

Y = F(K,P)

 

Because of constant returns to scale, per capita production function:

y = f(k)

 

Evolution of Inputs to production:

dk/dt = sf(k) – (n+ δ)k

 

Capital Stock’s Growth rate in steady state

gK = (dY/dt)/K

   = n

(Capital stocks grows (gK) just to keep up with population growth rate (n)]

 

Economy’s Growth rate in steady state

Y = (dY/dt)/Y

   = n

(Economy grows (gY) just to keep up with population growth rate (n)]

 

Assumption:

1)      A closed economy

2)      Constant exogenous population growth

3)      Production Function assumptions:

  • ·         Marginal products positive

  

  • ·         Marginal products diminishing

  

  • ·         Constant returns to scale

  

 

Endogenous:

Y = output (and income)

K = capital stock (or K(t))

P = population

Exogenous:

s = savings rate

δ = depreciation

ɵ = fixed coefficient production

n = Population growth rate (constant)

Implications

  • ·         Regardless of initial level of capita stock (k),  the economy converges to a steady state k*
  • ·         Per-capita income will converge to y*
  • ·         Growth of per-capita income at k* is 0:
  • o    Here capital stock is growing just to keep up with population growth
  • o    Here total income is growing just to keep up with population growth
  • ·         Comparative statics
    • o    s ↑ Þ k*↑, y*↑
    • o    δ↑ Þ k*↓, y*↓
    • o    n↑ Þ k*↓, y*↓

Limitations/Criticisms

Example

  • ·         It is difficult to reconcile with key features of the data:
  • o   Lack of absolute convergence
  • o   Lack of investment flows from rich to poor countries
  • o   Countries that initially appear to be very similar that subsequently experience very different growth paths

South Korea and The Philippines while appear to be similar, they grew differently.

 


 

 

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