Question

Discuss the key predictions and limitations of the Solow Growth Model. Estimating TFP growth rates. This question requires the student to calculate TFP growth rates of various economies and discuss their implications. 750 words

Answer 1

Solow Model of Growth:- Prof. R.M. Solow makes his model of economic growth upon the Harrod-Domar model. It is the basic modern theory of economic growth.

Main predictions of Solow Model of Growth :-

The Solow model predicts conditional convergence, i.e. once we control for observable differences between countries (that will affect their steady-state level) such as investment rate, human capital, population growth, and key variables that could be summarized by A such as protection of property rights, financial situation etc.

Assumptions :- 1. Full employment of labour,
2. Full employment of the stock of capital,
3. Lobour and capital are substitutable,
4. Saving remains constant,
5. One compound commodity is produced.

The model:- In the model, Solow shows that there is same tendency of capital-labor to adjust itself through time in the direction of balance. He says that if the ratio of the capital to labor is more, capital and output would increase slowly than labor.
Solow take one compound commodity in the economy. And its yearly rate of production is represented by Y(t), which represent real income and part of it consumed and rest of it saved and invested.
The steady state is the basic to comprehensing the Solow Model. At the steady state an investment is equivalent to depreciation. That means that all of investment is being accustomed to mend and restore the existing capital stock.

Diagram :-

In the following diagram, nr is the origin function and other curve represent SF( r,1), which is MPC. At the ponit of E both nr = SF (r,1).

Limitations:- There are some limitations in this model,

1. There is no mention of investment and saving function which is very important for an economy.

2. Labour and capital are not perfect substitute always.

3. Unrealistic assumption make this model wrong.

4. Solow ignores the problems of technical issues.

Estimating the TFP growth rate:-

Total factor productivity (TFP) is a meter of productivity computed by,
economy-wide total production / the weighted average of inputs. It presents growth in real output which is in surplus of the growth in inputs such as labor and capital.

year country TFP growth rate

2011 China 1.68
2011 India 1.49
2011 US 1.11
2011 EU 0.99
2011 Brazil 0.92
2011 Japan 0.99

Implications of TFP of growth rate :-

The studies show that TFP has a big impact on economic growth than fixed capital creation and employed labour for all country groups. Besides this, the impact of TFP on economic growth was found to be big for developed countries than for emerging countries.