Answer to Question #282467 in Macroeconomics for ABEX

Question

Consider three of the stylized facts of economic growth: (i) there is a

sheer level of difference across countries in terms of level of income, (ii)

there are differences in long-run growth of economies in the world, and

(iii) economic positions of countries are not immutable.

(a) Discuss how the Solow growth model addresses the three stylized

facts.

(b) What are the major contributions of the Ramsey-Cass-Koopmans

model over the Solow model? How do they differ from the Solow

model in terms of their implications for the three stylized facts

above?

(c) What is the major shortcoming of the Solow growth model?

(d) The AK models are the first generation models in an attempt to

endogenize technology. Why are they still categorized as neoclassical growth models?

(e) Whose works mainly constitute the AK models?

(f) Briefly discuss how theories of expanding varieties, quality ladder,

and technological transfer attempt to fill the gaps in the neoclassical growth model in addressing the three stylized facts?

Answer 1

a)     Solow growth model is a long-term model of economic growth which looks at three main factors including; accumulation of capital, growth of labour and multi-factor productivity. The latter is referred by economists as technological progress and which affects the other two variables. The main conclusion of the model is that the accumulation of physical capital cannot account for either the vast growth over time in output per person and accumulation of capital creates growth in the long-run only to the extent that it embodies improved technology

b)     The major contributions of Ramsey–Cass–Koopmans is that the choice of consumption is explicitly micro-founded at a point in time which endogenizes the savings rate and as result, the saving rate is not constant along the transition to the long run steady state. Another implication of the model is that the outcome is Pareto efficient. He only explained long-run economic growth rather than business cycle fluctuations, and did not include any sources of disturbances like market imperfections, heterogeneity among households, or exogenous shocks.

The difference between Solow model and Ramsey model is that Solow model assumes an exogenous saving rate while the Ramsey model features a household which acts as a representative and chooses the saving rate optimally.

c)      Even though the Solow model is a growth model it does not really explain long run growth. The per capita income does not grow at all in the long run and the aggregate income grows at an exogenously given rate and the model does not try to explain.

d)     The AK model are still categorized as neoclassical because they were theoretically unsatisfactory as tools to explore long run growth as they predicted economies without technological change and therefore, they would eventually converge to a steady state, with zero per capita growth. A fundamental reason for this is the diminishing return of capital and the key property of AK model is the absence of diminishing returns to capital. In neoclassical growth models, it is assumed that the economy reaches a steady state in which all macroeconomic variables grow at the same rate and in the absence of technological progress, per capita growth of these macroeconomic variables eventually ceases.

e)     Arrow (1962) came up with the idea that productivity could be increased as the result of learning-by-doing externalization and then Lucas (1988) developed an AK model where the creation and transmission of knowledge takes place through accumulation of human capital.

f)      Expanding varieties model states that the key to understand technology is through adoption of R&D and technology on purposeful activities. This Model assumes that research leads to the creation of new varieties of inputs (machines) and a greater variety of inputs increases the division of labor and process innovation.

Quality ladder model states the range of qualities within a market arises if the benefit and cost of increasing quality varies across markets. It encourages continues improvement of quality through technological improvement.

Technology transfer model involves the implementation of scientific or technological information in a context different from that for which it was developed. Successful transfer proceeds in a certain sequence of activities, with evaluation and information feedback at each of 4 decision stages:

(1) The search stage – here the recipient and the donor determine their respective needs and capabilities, the compatibility of their policies and priorities, and their personal compatibility.

(2) The adaptation stage – Here the project's social and economic desirability and feasibility are studied

(3) The implementation stage – At this stage, the necessary capital and human resources are marshaled.

(4) The maintenance stage – Here the project is put into full-scale operation.

If at any stage a project is found to be ineffective, it should be altered or stopped and this addresses the issue of technological gaps through continuous improvement.