Introduction
The Solow-Swan model, also known as the neoclassical growth model, is an economic model of long-run economic growth. Developed independently in 1956 by American economists Robert Solow and Trevor Swan, it seeks to analyze the determinants of capital accumulation and economic growth in terms of population growth, physical capital accumulation, and technological progress. The central finding of the model is that the long run economic growth rate is determined by the rate of technological progress.
Overview
The Solow-Swan model stands on two core assumptions. First, the amount of capital invested in the economy is determined by the savings rate, which is exogenous to the economy. Second, the growth rate of technology is also exogenous. As such, the economy is assumed to be open and technological knowledge is assumed to be perfectly available in each period.
The central question that these two assumptions allow the model to address is: What determines the size of an economy over time? The Solow-Swan model can be used to answer this question by looking at the relationships between savings, capital accumulation, population growth and technological progress.
The Solow-Swan model consists of a set of equations of the total capital stock, the amount of new capital accumulation and the amount of capital depreciation which are then related to the growth rate of output and employment. These equations form the foundation of the Solow-Swan model:
- The level of capital stock (Kt) is determined by the amount of new capital accumulation minus depreciation of the existing capital stock.
- The new capital accumulation (At) is determined by the amount of savings (St) minus the required amount of investment (It) necessary, which is equal to what the amount of output produced that is necessary to maintain the status quo.
- The rate of change of the capital stock (k) is equal to the new rate of investment (it).
- The growth rate of output (Gt) is determined by the level of capital stock (Kt) and technological progress (A).
- The growth rate of employment (L) is determined by the population growth rate (N) and technological progress (A).
The model is able to explain the growth of capital, output and employment in the long run equilibrium. The main result of the Solow-Swan model is that the long run economic growth rate is determined by the rate of technological progress.
Conclusion
The Solow-Swan model is a seminal work in both macroeconomics and long run economic growth theory. It provides the foundation for understanding long run economic growth and how various factors interact to determine the long run economic growth rate. In addition, it has provided the framework for current economic literature on the relationship between savings and economic growth and is widely cited in the economic literature. In sum, the Solow-Swan model remains an invaluable tool for understanding and predicting long run economic growth.
