Answer to Question #253293 in Macroeconomics for vtg

Question

development theories ,mostly those developed by economists from developed economies are foundations for economic policies in many developing countries,they however have shortcomings.

critically discuss the above statement with regard to the Solow growth model.

Answer 1

Solution:

Development theories such as the Solow growth model have helped a lot in mapping out economic growth policies in developing economies. It is used to explain the shifting economic fortunes of developing economies.

The Solow Growth Model is an exogenous economic growth model that examines changes in an economy's output over time as a result of changes in the population growth rate, savings rate, and rate of technological progress.

The Solow model serves as the foundation for modern economic growth theory. It provides a useful framework for understanding how technological progress and capital deepening interact to determine output per worker growth rates.

The Solow model is successful in explaining all stylized facts about economic growth in developed countries. Because returns to capital alone are declining, economies will grow faster at lower levels of capital until they reach a steady-state in which units of effective labor and capital grow at the same rate.

 

The following are the shortcomings of the Solow Growth Model:

·        Solow's model lacks an investment function, and once it is introduced, the Harrodian problem of instability is quickly reintroduced by the Solow model.

·        There is no distinct saving function that can be associated with the entire production function because the national economy involves many different types of people, whose combined savings are based on revenue distribution and several other factors that vary depending on the type of production outcome.

·        The Solow model assumes capital is homogeneous and malleable, whereas capital goods are heterogeneous in nature. Aggregation problems arise as a result of their heterogeneous nature.

·        Solow Model assumed that factor prices would be flexible, which could complicate the path to steady growth. For example, the problem of a liquidity trap may prevent the interest rate from falling below a certain minimum level. This, in turn, may prevent the capital-output ratio from rising to the level required to achieve the path of equilibrium growth.

·        Solow's model excludes technical progress as a cause and instead treats it as an exogenous factor in the growth process. As a result, he ignores the issues of inducing technical progress through the processes of learning, research investment, and capital accumulation.