According to our previous videos in this section, the Solow model seems to predict that we’ll always end up in a steady state with no economic growth. But, the
According to our previous videos in this section, the Solow model seems to predict that we’ll always end up in a steady state with no economic growth.
But, the Solow model still has one variable unaccounted for: ideas.
So, can ideas keep us growing?
Ideas do one thing really well: they give us more bang for our buck.
This means we get more output for the same inputs of capital and labor. Ideas are a way of upping our productivity, increasing output per worker across different industries.
Just how much extra output are we talking about?
Well, imagine changing the A variable of the Solow model from 1 to 2. This means a doubling of our productivity.
This shifts the entire output curve upward. When output doubles, so does investment. Once investment comes in faster than depreciation, we end up accumulating capital once again.Thus, the economy keeps growing, which further boosts output.
Now, think of what would happen, if ideas continually improved. With each improvement, ideas would keep shifting the output curve upward, which will continually increase investment as well, and allow us to keep to the left of the steady state.
And when we stay to the left, that means we keep growing.
What all this means is, growth at the cutting edge is determined by two things.
First, it's determined by how fast new ideas are formed, and second, by how much those ideas increase productivity.
You now have a complete picture of our simple Solow model. It's a model that accounts for catching up growth, due to capital accumulation, and cutting edge growth, due to the buildup of ideas.
Now, since ideas foster growth at the cutting edge, we're left with the question that naturally follows: what factors help spur the accumulation of ideas?
That's what we'll discuss in the next video, so hang tight!