The Neoclassical Growth Models

Presented By :- Sanjukta Kar

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Introduction

I will discuss the Solow Swan model which points out the effects of saving, technological advance
and population expansion.

Next I go over the Ramsey, Cass and Koopmans's closed economy model with intertemporally
utility maximizing infinitely lived generations.

Lastly, I discuss a version of the overlapping generations model.

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The Solow Swan Model of Fixed Savings

Solow and Swan (1956) incorporated a supply side to the Keynesian aggregate demand framework.
 
Lets look at the model-
 
The new element which is of interest is technological progress. Technological shocks are classified as

Hicks Neutral with production function as—

  where A is the exogenous productivity parameter,

where E is the labor augmenting technological shift parameter and EL is the supply of efficiency units of labor.
 

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The demand side--

The economy is closed and there is no government. Private savings S is a fixed fraction s of current

income Y. So we can write-

1.

We have a closed economy. So domestic savings= domestic investment. The capital accumulation
equation is given by –

2.

Where delta is the rate of depreciation.

The level of Harrod Neutral productivity E grows at the rate

3a.
 
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The population grows at the rate

(3b)

Our next step is to normalize all variables by the efficiency labor supply

“EL” . The capital to efficiency labor ratio is

(4)

We divide the capital accumulation equation by efficiency labor unit to get--

(5)

(6)

where (1+z) =(1+n) (1+g)

Re-writing equation 5 as

(7)

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where is the intensive form of the production
function.

Equation (7) is the main equation of the Solow Model. The first term inside

brackets is the gross savings per efficiency worker in period t. The second

term inside brackets shows k decreases due to depreciation and the growth

in efficiency unit of labor. We divide the term in brackets by 1/(1+z) as any

effect on net investment in period t will be felt by efficiency workers in

period (1+t).

Now the Solow Swan model is represented diagrammatically--

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Comments - We have a concave production function and a concave

savings curve as savings is proportional to output. The distance between

the two curves is the consumption per efficiency unit of labor. The 45

degree line gives the savings needed to maintain any level of capital in

efficiency unit.

Dynamics

When the savings are inadequate to maintain the

capital stock. So the capital per efficiency unit is falling. We have

. The opposite happens when capital stock is low. Overtime the

economy converges to the steady state where we have equality.

Eventually we get the long run equilibrium at which we have

1) is constant

2) As EL grows at the gross rate K and Y also

grow at the same rate.

3) Steady state per capita output Y/L grows at the rate of technological

advance

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Implications

Effect of a decline in savings rate

When savings fall capital efficiency labor ratio falls. Per capita income falls.

The growth of these variables fall temporarily. Eventually the economy

adjusts to its new lower levels and achieves its former level of growth.

Effect of a rise in the population growth rate

Reduces the steady state output per capita as line rotates

upward as capital per efficiency unit falls.

Economic logic -- Solow model has the assumption of fixed savings rate.

So a higher population diminishes the capital resources.

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The Ramsey- Cass - Koopmans Growth Model with Infinitely Lived
Representative Dynasty
Let’s think of a world with identical and infinitely lived dynasties. Each

dynasty have a size L and they grow at an exogenous rate of (1+n) so that

we have

We have egalitarian dynasty planners who weigh the consumption of each

generation in proportion to its size. At each date t the representative

household maximizes

(8)

where ct is the consumption of the representative member alive at time t.

Condition for bounded dynasty utility is

As with Solow the labor augmenting technological progress is given by

There is no depreciation.

The budget constraint is

(9) 10
 Dividing by Lt we get

(10)

Here we are dealing with per worker production function.

Maximizing equation 8 with respect to equation 10 we get the first order Euler equation-

(11)
With isoelastic production function

(12)

we have the following

Euler equation

(13)

Dividing both sides of 10 and 13 by EL we get

(14)

(15) 11
Steady State values

We get the steady state value of capital per efficiency labor when

consumption is not changing as given by the vertical line.

(16)

We get the steady state value of consumption per efficiency unit of labor

when capital is not changing as given by the hump shaped curve.

(17)

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Dynamics of the Model

To the right of the steady stock of capital the capital is above its steady state value, so
the marginal product of capital is below the steady state value of marginal product.
So consumption is falling. Consumption rises to the left of the vertical line.

If equation 14 is less than zero then consumption is above its steady state value. We
have a zone of rising consumption and falling capital.

For any initial level of capital per efficiency unit there is an unique consumption thus
enabling the economy to move along the saddle and converge to the steady state. 13
Implications

Effect of a decline of the patience factor beta

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People consumes more and savings decline. `From equation 16 we find the

steady

state value of capital per efficiency unit falls as people become more

impatient i.e. they have a lower beta. This situation is analogous to the fall

in savings rate in the Solow Model.

A lower beta leads to an upward jump in consumption to the new saddle

path. But we find the capital stock has fallen as well.

So lower capital stock leads to a decline in output per efficiency unit and

consumption per efficiency unit and in the new long run position the new

consumption is lower than the initial steady state value.

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Effect of a rise in the population growth rate

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The schedule shifts down but the schedule is
unchanged.

At the new steady state we have

Unchanged capital stock per efficiency unit.

Unchanged output per efficiency unit

A decrease in consumption in efficiency units.

Difference with Solow - The path of output is doesn't fall as opposed to the

Solow Model.

with a fixed savings as we have forward looking planners who take care of

the utility of the future generation in making today’s consumption choice.

When they expect a higher population in the future they cut back on

consumption today to provide the same path of capital and output for their

progeny.

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An Overlapping Generations Growth Model
Assume individuals maximize utility according to the utility function

(18)

Total population = labor supply and grows at the rate n.

Each period agents earn income from wages and from renting out capital.
The budget constraint is

(19)

v is defined as family vintage.

Maximizing utility with respect to budget constraint we get the Euler

(20)

Using and = we get the budget equation in

per capita terms.

(21)

By using we get the closed economy overlapping

generations model as

(22)

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Dynamics

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Like before a rise in population shifts the curve downwards.

schedule moves upward.

We have a reduction in capital labor ratio like the Solow model.

As the present generation does not care about unborn future generations

the steady state capital stock will be inefficiently high.

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Comments

Questions?

Suggestions?

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