Lecture: The Solow-Swan Model
Ph.D. Alberto Gallegos
Universidad Autónoma Chapingo
División de Ciencias Económico Administrativas (DICEA)
July 5, 2025
1 Introduction
Neoclassical growth models have two important branches: exogenous and en-
dogenous consumption-savings decision. Precisely, the Solow-Swan model re-
views some of the mainstream arguments in a clear and concise way aiming
at covering an updated vision about economic growth, stilized facts, and their
economic implications within a framework of an exogenous savings rate.
2 Production and consumption sides: general
assumptions
General assumptions:
Consumers
i) Consumers are owners of productive factors and assets.
ii) Consumers take both, consumption and savings choices.
iii) Consumers decide the number of children, if enter the economic active
population and their labour e¤ort.
Firms
i) Firms, hire capital and labour in the productive factors’market,
ii) Firms have access to new technology,
iii) Perfect competition applies both, in the factors’ market and the …nal
goods’market.
Production functions
i) Production functions exhibit constant returns to scale,
ii) In addition to labour L and capital K, the state of technology is consid-
ered, i.e., A.
We are about to consider a discrete aggregate production function of the
following form:
Yt = F (At ; Lt ; Kt 1) (1)
1
Where output depends on two aggregate inputs: labour Lt and capital Kt 1 ;
and the productive-state of technology parameter At 1 .
Aiming at concentrating solely on the capital accumulation and their growth
e¤ects, we addtionally are assuming that growth in population and productiv-
ity are predetermined and constant over time. Furthermore, consumers in-
vest a …xed fraction of output every other period, implicitly deciding their
consumption-savings decision2 .
Let us start by explicitly showing the production function:
Yt = F (At ; Lt ; Kt 1) = (At Lt ) (Kt 1) (2)
In the Solow-Swan Model the discrete motion of the capital accumulation is
as follows:
Kt Kt 1
=
Kt 1
This means that in the abscense of investment It , capital just depreciates at
the rate every period. Appropriately arranging the last equation, we have the
"low of motion" of capital accumulation considering It > 0:
Kt = Kt 1 Kt 1 + It
=)
Kt = Kt 1 (1 ) + It
The same conclusion arises: if investment It at time t is zero, accumulated
capital depreciates at rate constant over time, where 2 (0; 1).
One of the implications of assuming an exogenous or predetermined rate of
savings, is that in equilibrium, the savings rate s is also the investment rate,
i.e., it is related with the marginal propensity to invest in the general expression
for a behavioural general investment function over time:
It = b0;t + b1;t Y b2;t i
where each parameter is positive accordingly with the speci…cation of the
investment function, therefore s 2 (0; 1). This model also provides exogenously
productivity and population (labour) growth at …xed predetermined rates:
and , respectively. This means that for the technology parameter:
At+1 At
=
At
At+1
= 1+
At
=)
At+1 = (1 + ) At
1 If A enters in the form of Y = AF (K; L), technological progress is assumed to be Hicks-
neutral. If it enters Y = F (AK; L), technological progress is capital-augmenting. In this note,
it is labour-augmenting, that is Y = F (K; AL).
2 In the Solow-Swan model the savings rate is exogenously determined.
2
and for labour:
Lt+1 Lt
=
Lt
Lt+1
= 1+
Lt
=)
Lt+1 = (1 + ) Lt
Let us assume that there is a competitive representative …rm facing the typ-
ical problem of maximizing revenues or minimizing costs through the following
function t (At ; Lt ; Kt 1 ):
max t (At ; Lt ; Kt 1) = (At Lt ) (Kt 1) (wLt + rKt 1)
fLt ;Kt 1g
where: t (At ; Lt ; Kt 1 ) is the bene…t function that re‡ects total revenues
minus total costs.
Like any other economic model the best known practice is to have a "mar-
ginal approach". In this context, we are interested in the "e¤ective labour"
features of the Solow-Swan model. Let us de…ne the "e¤ective labour" concept.
The production function is homogenous of degree one. That allows us to
modify the production function with a parameter of proportion adequately cho-
sen, i.e., , where:
1
=
At Lt
That is the factor associated with the measure "per unit of e¤ective labour".
If this factor of proportion was:
1
=
Lt
That would be the factor associated with the measure "per unit of labour"
or "per capita". Applying the former factor of proportion to the aggregate
production function of the representative …rm we have:
1
Yt (At ; Lt ; Kt 1) = Yt (At ; Lt ; Kt 1)
At Lt
At Lt Kt 1 Kt 1
= = = (kt 1) = yt
At Lt At Lt At Lt
=)
yt = kt 1
The last equation represents the product per unit of "e¤ective labour" that
depends on the given capital per unit of "e¤ective labour". Substituting these
results into the equation that represents the accumulation of capital in terms of
" units of e¤ective labour" we have:
3
Kt 1
= kt 1 =) Kt 1 = kt 1 At Lt
At Lt
Kt
= kt =) Kt = kt At+1 Lt+1
At+1 Lt+1
Considering the investment is positive, we can have the same interpretation
on the investment in terms of "per unit of e¤ective labour" or "per capita", i.e.,
It
it =
At Lt
or
It
it =
Lt
At this point, remember that the aggregate investment It exogenously de-
pends on the rate of savings s. In other words,
it = syt
where
Yt Yt
yt = =s = syt
At Lt At Lt
or
Yt Yt
yt = =s = syt
Lt Lt
depending on the the representation, i.e., in terms of per unit of e¤ective
labour, or in terms of per unit of labour (per capita terms).
In terms of units of e¤ective labour, the law of motion of capital accumulation
once proportional changes are integrated:
Kt = (1 ) Kt 1 + It
kt At+1 Lt+1 = (1 ) kt 1 At Lt + It
1
At Lt
At+1 Lt+1 It
kt = (1 ) kt 1 +
At Lt At Lt
kt (1 + ) (1 + ) = kt 1 (1 ) + it
kt (1 + ) (1 + ) = kt 1 (1 ) + skt 1
=)
kt 1 (1 ) + skt 1
kt =
(1 + ) (1 + )
1
kt 1
kt (1 ) + skt 11
=
kt 1 (1 + ) (1 + )
4
The last expression is known as the gross growth rate of capital per e¤ective
labour. Because this rate shows an inverse relation with the capital stock kt 1 ,
at some point in time this rate becomes zero.
In the meantime let us assume = 0 = . Under these circumstances, the
gross growth rate of capital per e¤ective labour follows the equation:
kt = (1 ) kt 1 + skt 1
=)
kt kt 1 = skt 1 kt 1
The last expression representing the change in the capital stock over periods.
Due to the inverse relation between the gross growth rate of capital and the
capital stock, the capital accumulation per unit of e¤ective labour is equal to
the di¤erence between investment and depreciation at the break even point:
kt kt 1 = 0
=)
skt 1 = kt 1
Once the capital stock becomes constant -in the very long run-, i.e., where
k = k at the steady state, we can obtain a number of variables with a speci…c
solution precisely where the change in capital per unit of e¤ective labour reaches
in a delicate balance the same amount of investment. It is worthwhile noting
that at the very long-run steady state,
kt kt 1 = 0 =) kt = kt 1 =k
According to the low of motion of capital, we have:
k (1 + ) (1 + ) = k (1 ) + it
k (1 + ) (1 + ) = k (1 ) + sk
5
The capital stock then at the steady-state becomes:
k (1 + ) (1 + ) = k (1 ) + sk
=)
k (1 + ) (1 + ) = k (1 ) + sk
k (1 + ) (1 + ) k (1
= sk )
=)
1
kf + + + g = sk = skk
=)
k f + + + g = s
=)
s
k =
+ + +
=)
1
s
k =
+ + +
Simplifying this expression
k f(1 + ) (1 + ) (1 )g = sk
kf + + + g = sk
Before doing anything else, take into account that + = 1 which implies
that = 1 . Substituting this piece of information into the last expression,
we have the steady-state’s level of capital per unit of e¤ective labour:
1
kf + + + g = sk = sk = skk
=)
1
kk
k kk
f + + + g = s
kk kk
k f + + + g = s
=)
1
s
) k=
+ + +
Substituting into the production function we have the output level per unit
of e¤ective labour at the steady-state:
yt = k
6
Therefore:
( 1 )
s
yt =
+ + +
1
s s
yt = =
+ + + + + +
Likewise if we obtain the level of investment per unit of e¤ective labour at
the steady-state, we have:
( 1 )
It s
= it = syt = skt 1 = sk = s
At Lt + + +
=)
s
it = s
+ + +
At the same time, at the steady-state the growth rate of capital is the fol-
lowing:
Kt kt At+1 Lt+1 kt
= = (1 + ) (1 + )
Kt 1 kt 1 At Lt kt 1
notice that at the steady state, kt = kt 1 = k, therefore:
Kt kt At+1 Lt+1 kt k (1 + ) (1 + )
= = (1 + ) (1 + ) = = (1 + ) (1 + ) = (1 + ) + (1 +
Kt 1 kt 1 At Lt kt 1 k
=)
Kt
1 = + +
Kt 1
Kt K t 1
= + +
Kt 1
The last expression representing the growth rate of the capital stock at the
steady state. Notice that this expression does not depend on the savings rate s.
Three more stylised facts of growth remain to check. The return to capital
must be constant. From eq.(1) we know that the production function takes the
following speci…c form:
Yt = (At Lt ) Kt 1
We also know that the marginal product of capital must be equal to the price
of capital, i.e., r
1
rt = (At Lt ) Kt 1
7
at the steady state, the capital per unit of e¤ective labour, i.e.,
Kt 1
= k
At Lt
Kt 1 = kAt Lt
This last expression is useful to substitute into the marginal productivity of
capital
1 1
rt = (At Lt ) Kt 1 = (At Lt ) kAt Lt
1 1 1
rt = (At Lt ) kAt Lt = (At Lt ) (At Lt ) k
+ 1 1 1
rt = (At Lt ) k = k
rt+1 (1 )k
= =1
rt (1 )k
If we had the expression of the interest rate between periods depending on
the amount of capital per unit of e¤ective labor: the interest rate would be
constant at the steady state.
1
rt = k
1
rt+1 = k
1
rt+1 k
= 1
=1
rt k
Likewise, for the price of labour, i.e., the wage we have:
1
wt = At Lt Kt 1
Reexpressing in terms of capital per unit of e¤ective labour we have at the
steady state:
1 1
wt = At Lt Kt 1 = At Lt kAt Lt
wt = At + Lt 1+
k = At k
which at the steady state becomes:
wt = At k
=)
wt+1 At+1 k At+1
= = = (1 + )
wt At k At
8
2.1 Example
Suppose you have the following production function with some parameters given:
Yt = At Lt Kt 1
with:
At = 3
Lt = 150
= 0:7
= 0:3
= 0:1
s = 0:2
Solve for the steady state levels noting that = 0 = ;i.e., there is neither
technological nor population or labour changes:
1. Level of capital per unit of e¤ective labour,
(a)
Kt 1
= kt 1 =) kt 1 At Lt
At Lt
Kt
= kt =) kt At+1 Lt+1
At+1 Lt+1
From the general production function form:
Yt = (At Lt ) Kt 1
and the law of motion of capital:
Kt = (1 ) Kt 1 + It
that in terms of units of e¤ective labour, becomes:
kt At+1 Lt+1 = (1 ) kt 1 At Lt + It
At+1 Lt+1 It
kt = (1 ) kt 1 +
At Lt At Lt
kt (1 + ) (1 + ) = (1 ) kt 1 + it
(1 ) kt 1 + it
kt =
(1 + ) (1 + )
kt = (1 ) kt 1 + skt 1 () =0=
9
At the steady state:
kt = kt 1 =k
Substituting, we have
k = (1 ) k + sk
1
k
1 s
1 = (1 ) + sk = (1 ) + sk = (1 )+
k
1
s
k =
Substituting parameters in the last expression of capital per unit of
e¤ective labour we have:
1
0:2 0:7
k= = 2:691 8
0:1
(b) Level of capital.
If the proportional factor is:
1
=
At Lt
which according to the function and …gures given is:
1
Yt = At Lt Kt 1 =) At Lt Kt 1
1
Yt = At Lt Kt 1
=)
1 1
At = (3) 0:7 = 4:804 0
Lt = 150
therefore:
1 1
= =) = (4:804 0) 150 = 720:6
(4:804 0) 150
So that the level of the aggregate stock of capital at the steady state
is:
1
K = kA L = 2:691 8 (4:804) 150 = 1939: 7
(c) Level of output per unit of e¤ective labour,
0:3
y = k = (2:691 8) = 1:345 9
10
(d) Level of output,
1
Y = yA L = 1:345 9 (4:804) 150 = 969: 86
(e) Level of investment per unit of e¤ective labour,
i = sy = 0:2 (1:345 9) = 0:269 18
(f) Level of aggregate investment,
1
I = iA L = 0:269 18 (4:804) 150 = 193: 97 = 0:2 (969:86) = sY
(g) Factor prices wt and rt
In general
1 1
wt = At Lt Kt 1 = (At Lt ) At Kt 1
1
multiply by to reexpress the last expression:
At Lt
1
At Lt Kt 1
wt = At = At kt 1
At Lt At Lt
substitute the given numbers in the steady state equilibrium where
kt 1 = kt = k:
0:3
w = At k = 0:7 (3) (2:691 8) = 2:826 4
(h) Growth rates of factor prices wt and rt ;
Constant for both factor prices given k = 2:691 8 and =0= :
(i) Capital output ratio per unit of e¤ective labour,
Kt 1
At Lt kt 1
=
Yt yt
At Lt
that in the steady state becomes:
2:691 8 k kt 1 k 1 1 (1 )
= = = =k =k =k
1:345 9 y yt k
substituting numbers we have:
0:7
k = (2:6918) =2
(j) Capital output ratio:
Kt 1 K 1939:7
= = =2
Yt Y 969: 86
2.2 Bibliography
Barro, R. (1997). Macroeconomics. MIT Press.
11
