Solow Growth Notes

Trevor Gallen
September 9, 2016

Aside about logs

To start, I want to note a nice result that says the percentage change in a ratio is approximately
the percent change in the numerator minus the percent change in the denominator. We start
by noting that a log difference is approximately a percent difference:
log(x) log(
x) = log

x

x
1
x

xx

=
x

= %x

Then we note that for the percentage change in a ratio:

 
x
x

log
log( ) = log(x) log(y) log(
x) + log(
y)
y
y
 
x
y
= log
log
x

y
= %x %y

Main Solow

2.1

Change in GDP

We start with the production function Yt , which is a function of capital Kt , labor Lt , and
productivity (sometimes called total factor productivity At .
Yt = At Kt Lt1

(1)

We divide by Lt to get per-capita GDP in terms of per-capita capital:

Yt
= At
Lt

Kt
Lt

  1
Lt
t
Lt

Which, using lower case letters for per-capita GDP and capital, gives:
yt = At kt

(2)

We can note that by totally differentiating equation 2, we get:

dyt = kt dAt + At kt1 dkt
Dividing by yt :
dyt
dAt
dkt
=
+
yt
At
kt
Noting that kt =

Kt
Lt ,

we can use our aside about logs (and noting that

dXt
Xt

is the percent change

in Xt ):
dyt
dAt
=
+
yt
At

dKt dLt

Kt
Lt


(3)

Equation 3 is important, its saying that per-capita GDP growth can be broken up into productivity growth, total capital growth, and total labor growth.

2.2

Can Capital Explain Growth?

Now well examine a model in which capital accumulation is the only driver of growth. Well
assume three things:
1. Productivity doesnt change:

dAt
At

=0
2

2. Labors growth rate is constant:

dLt
Lt

= n, n a constant.

3. People save a constant amount of their net real income: realsavings = s(Yt Kt ).
4. The law of motion of capital is: Kt = It Kt
We need to link savings and capital accumulation. We can note that net real income is equal to
real consumption plus real savings:
Yt = Ct + s(Yt Kt )

(4)

And we can also recall that total GDP is gross investment plus consumption:
Yt = Ct + It

(5)

Subtracting Kt from both sides of equation 5,

Yt Kt = Ct + It Kt

(6)

The difference between equation 6 and equation 4, we can solve for It :

It = s(Yt Kt ) Kt

(7)

Plugging this into the law of motion for capital from our assumptions above:
Kt = s(Yt Kt )

(8)

This is simple, but important: net savings is net investment. Growth in capital (and growth in
GDP per capita, in turn) comes from putting off consumption and investing. Taking equation
8 and dividing by Kt :
Kt
=s
Kt

Yt

Kt


(9)

We now have an expression for change in capital! We can plug this into equation 3 along with
our assumptions about productivity growth and labor growth:
dyt
Yt
= s
s n
yt
Kt
3

(10)

Or, if we were to look just at capital accumulation, noting that under our assumptions
dyt
yt

t
= dk
kt and divide the top and bottom of Yt /Kt by Lt :

dkt
yt
= s s n
kt
kt

(11)

Finally, if we plug in the Cobb-Douglas production function, yt = Akt :

dkt
sA
= 1 s n
kt
Kt

(12)

Equation ?? and equation 12 are very important! Theyre saying that the growth rate of capital
has three components that we can see very clearly. Barro prefers equation 11, I think equation
12 is clearer.

2.3

Three Components

The three components of the growth rate in capital/capita (and thus of GDP/capita) are:
1.

sA
:
Kt1

the growth rate of capital is related to what you save: when your productivity is

higher, or your savings rate is higher, you save more. When your capital is higher then
its less productive, and your growth rate is lower. Note that diminishing returns
2. s: the growth rate of capital is related to depreciation (which is a bigger factor when
capitals coming from savings). When depreciation is high, the growth rate of capital falls.
3. n: the growth rate of labor. When the population grows faster, it takes more investment to
keep up and keep capital per capita the same. Holding all else constant, a faster growth
rate with the same savings will make capital per capita shrink (or grow more slowly).
We will talk more about the graphs related to these in future classes. I encourage you to
read Barro Chapter 3 for more detail and an alternative take.