Answer to Question #145303 in Macroeconomics for Atif Saeed

Question

Solow model assumes other things remain the same, certain variables can explain the difference in GDP per capita, investment rates etc. Across the countries:
Choose two countries one rich other poor. From World development Indicator: take the data on the GDP per capita and then take variables given by Solow model and explain the difference in the income per capita between the specific countries you have chosen, which according to you is most responsible for the observed difference.

Answer 1

Let's consider the application of the Solow model on a specific example from the history of the world economy. In 1945, the economies of Japan and Germany were in a state of complete collapse, up to 60% of fixed assets were destroyed. However, in just 30 years, both of these states become the most highly developed countries in the world. In Japan, between 1948 and 1972, per capita production grew by 8.3% per year, in Germany - by 5.7%. In the United States, at the same time, the growth rate was 2.5%.

From the point of view of the Solow model, the stable state of the economies of Japan and Germany (k *) was violated, the war destroyed the available volumes of capital, and they dropped to the point (& i). The level of production fell, but as the saving rate (the share of GNP going to savings and investment) remained constant, the economies of these countries gradually returned to their previous stable state. This required a period of rapid economic growth. Accelerated growth occurs due to the fact that at a low level of capital-labor ratio, investments exceed outflows and, thus, production grows, since investments provide more new capital than it goes out. The destruction of fixed assets in Japan and Germany led to a sharp drop in output, but then an investment boom followed, which many economists called an “economic miracle,” but it was fully in line with the predictions of the Solow model.