Economic Growth and Standard Neoclassical Model Essay

812 WordsApr 5, 20134 Pages
“Countries grow at different rates because they accumulate capital at different rates.” Is this true? Explain your answer. Eyeballing any cross sectional data on growth across countries shows that countries grow at different rates. Many theories try to explain this phenomenon with emphasis with capital accumulation being one of them. I will start by developing the standard neoclassical growth model as developed by Solow(1956)[1]. I will then proceed to discuss the extensions that have been made to this basic model in an attempt to better understand actual growth figures, for e.g. the standard neoclassical model cannot explain the magnitude of international differences in growth rates. Mankiw[2] points out that “the model can explain…show more content…
However, I=sY implying that investment is financed by savings in the economy. The growth rate of K is therefore KK=sY/K-δ. K can also be written as K=kAL and using the rules of growth rates, we can write the following; KK= kk+A/A+L/L. Denoting the rate of growth of technology A by g and rate of growth of labour by n and using the fact that KK=sY/K-δ, we can derive the growth rate of capital per effective worker as kk=sy/k-(n+g+δ) or k=sfk-n+g+δk. This is the fundamental equation of the neoclassical growth model. The economy reaches a steady state when the rate of change of capital per effective per worker equals zero. In other words, sf(k)=(n+g+δ)k. That is investment per effective worker equals the break even investment. This can be graphed as follows: The economy reaches a steady state at k*. Any other level of capital per effective worker will result in disequilibrium and the economy will converge back to k* . For e.g., if k is below k*, the amount of k is greater than break even investment which will increase k till it reaches k*. Likewise, if k is greater than k*, then k will be lower than break even investment which will reduce k till k equals k*. Thus we can see that the steady state k* will determine the steady state level of Y and hence we derive the fact that if a country has a higher rate of investment, it will have a higher steady state level of output showing our model can explain
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