Answer to Question #88794 in Macroeconomics for shivani

Question

compare the contrast between the ramsey model for the central planner and the solow model for economic growth(your answer should include the assumption,important equations phase daigram and its interpretation

Answer 1

Ramsey Model Assumptions:

- analyzes the behavior of a single household, which exists for an unlimited amount of time;

- the economy is considered as a closed system;

- the presence of perfect competition;

- time is continuous;

- on the market there is only one good that can be produced or consumed.

Solow Model Assumptions:

- there is only one product

- no government spending or taxes

- no change in unemployment

- production is determined by the aggregated function of only three factors of production: capital, labor, knowledge

- savings and depreciation rates are fixed

- the growth rate of the number and technical progress is constant

Actual investment can be either greater or less than balanced growth investment. Solow developed a famous diagram to explain what happens in the two cases. 

It shows the amount the economy saves per worker, and the amount of investment per worker needed to keep the capital stock growing at the same rate as the labour force (the straight line). The steady state occurs at the intersection where saving generates just the right amount of investment to stay on the balanced growth path.

If capital per worker is less than the steady-state level, investment exceeds the amount needed for balanced growth, and the amount of capital per worker rises. Hence, the economy tends towards its steady state.

The blue line represents the dynamic adjustment (or saddle) path of the economy in which all the constraints present in the model are satisfied. It is a stable path of the dynamic system. The red lines represent dynamic paths which are ruled out by the transversality condition.

https://www.youtube.com/watch?v=Dx7ZvAKfL9k

https://www.youtube.com/watch?v=9GGmmLVnkKs