Introduction to models of economic growth

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The Solow model: 

Economists have many annoying habits and many failings.

  One of the most 

remarkable is a penchant for looking at someone else’s work and attacking one simplifying assumption 

(however admittedly unrealistic) and introducing another simplifying assumption in its place.  The 

“neoclassical” (new classical) economists who in response to the failings of classical and Marxian price 

theory are an example.  Marx and classical economists assumed that the prices of things could be traced 

back to how much labor was used in an item’s production.  Neoclassicals, rightly, tore this to shreds but 

assumed away growth and development. Robert Solow  was guilty of this with respect to the Harrod-

Domar model.  He quite rightly took issue with one of the simplifying assumption employed in the H-D 

model; the assumption that there are constant marginal returns to capital.  This is what setting σ equal 

to 4002.46 per $10,000 worth of capital and keeping it there means.  With diminishing marginal returns

equal increases in capital yield less and less of an increase in output the more capital that had already 

accumulated.  The 4002.46 per $10,000 should fall more and more as an economy accumulates more 

capital. Both Harrod and Domar recognized that the assumption of constant marginal returns to capital 

was unrealistic but wanted to explore what happened to the Keynesian model (where sufficient demand 

is not guaranteed) once net investment had time to increase capacity. Solow proceeded to explore what 

diminishing marginal returns to capital would do  to the H-D model but fell back on the pre-Keynesian 

idea that actual (effective) demand was always enough to absorb capacity.  This model is outlined in the 

text, will be the focus of class handouts, and will be dealt with in class in detail this week and beyond so 

I needn’t repeat myself here.  In light of H-D all that we must note at present is that Solow assumes 

away the very real problem that actual (effective) demand may not grow at a rate fast enough to fully 

use added capacity.  Demand failing to grow sufficiently fast will obviously discourage continued 

expansion.  Why build more factories and create more jobs if the factory we just built is only running 

half the time? This is a very important point to keep in mind as we discuss trade (think China above) and 

development of the rural sector in the weeks to come but now on to Solow.   


Domar’s point that  

In equilibrium 





Adding in 



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