A summary of session 3 of the macroeconomic section of Economics 318 2015. The learner achieved a distinction in the examination with these notes. There is also a bundle available with sessions 1 to 8 for this course.
, Blanchard Chapter 11 (p.299)
Extensions of the Solow model
Human capital is the set of skills of the workers in the economy. The most natural way of extending
our analysis is to allow for human capital is to modify the production function relation to read:
𝑌 𝐾 𝐻
= 𝑓( , )
𝑁 𝑁 𝑁
Thus, the level of output per worker depends on the level of physical output per worker, as well as
the level of human capital per worker. For both physical and human capital per worker there are
decreasing returns to scale respectively (ie. individually).
How does the introduction of human capital change the analysis of the previous sections?
Our conclusions about physical capital accumulation remain valid: An increase in the saving rate
increases steady-state physical capital per worker and therefore increases output per worker.
Our conclusions now extend to human capital accumulation too. An increase in how much society
‘saves’ with regards to human capital (through education and on-the-job training) increases steady-
state human capital per worker, which leads to an increase in output per worker. Thus, in the long
run this extended model tells us that output per worker depends on both how much society saves
and how much is spends on education.
Exogenous vs endogenous growth models
Models that generate steady growth even without technological progress are called models
of endogenous growth to reflect the fact that in those models the growth rate depends,
even in the long run, on variables such as the saving rate and the rate of spending on
education.
Lucas and Romer asked the question of whether physical and human capital both increase in
tandem – would the economy not just grow forever by steadily having more capital and
more skilled workers?
This leads to growth that would retain momentum after an increase in saving (for example).
The growth rate is not an endogenous variable in the model.
The Solow model is characterised by exogenous growth in per capita GDP, as the source of
per capita growth is exogenous to the model (namely productivity). This is because
productivity is not explored in the model.
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