Solow Growth Lab (courtesy of Stephen DeLoach, ElonUniversity)

Purpose: This exercise will follow the laboratory method you are used to in science classes. The only difference is that you will be experimenting with simulated data. But, the process of analysis is similar. The purpose of this lab is for you to understand (1) the economic conditions that lead to equilibrium, or steady-state growth (i.e., what is the maximum sustainable rate of economic growth?); (2) the impact of changes in savings rates on the steady-state growth rate; (3) the impact of labor-augmenting technological innovation on the steady-state growth rate and subsequent effects on real wages.

Instructions:

There are 4 cases we must consider. They are given on separate sheets in the file SolowLab.xls. In each, you arechanging ONE assumption (initial condition) at a time. This will allow us to isolate the effectsof that assumption/condition on the growth rate of GDP.You will compare each case to the first, which provides us with a "baseline". In this exercise, we are using INDUCTIVE reasoning to make general inferences aboutthe implications of the Solow growth model.

After you complete the spreadsheet, you are asked to draw inferences. For each case, there are a series of discussion questions. Write out your responses in a WORD document. You will probably want to include sometime series graphs of the growth rates to clarify your arguments.

Case 1: Baseline

Assumptions:

1. initial (first period) Y=1,000

2. initial K=balanced growth level (HINT: you must use the theoretical balanced-growth condition to solve for the balanced-growth level of K; that is the initial level of K in the first period)

3. savings rate = .20 (savings = .2*GDP)

4. labor growth = .01 (%ΔN=.01)

5. tech. growth = 0 (%ΔA=0)

Discussion Questions:

  1. Describe the path of the GDP and the GDP growth rate (%ΔY)
  2. What conclusions can you draw? (HINT: you began in equilibrium and nothing changed, so…?)

Case 2: Adjustment Towards the Steady State

Assumptions:

1. Initial Y=1,000

2. pick an initial K<balanced growth level(e.g. 10,000)

3. savings rate = .20 (savings = .2*income)

4. labor growth = .01

5. tech. growth = 0

Discussion Questions:

  1. Create a line graph of the GDP growth rate. Describe what you see.
  2. What conclusions can you draw? What's the difference between Case 1&2? (hint: You began this case NOT in equilibrium and what happened?)
  3. What does this tell you about the stability of the system?(i.e., does the economy tend to return towards equilibrium?)

Case 3: Effects of Increased Savings Rates

Assumptions:

1. Initial Y =1,000

2. Initial K=balanced growth level of K

3. savings rate = .20 initially

4. labor growth = .01

5. tech. growth = 0

6. increase savings to .30 in period 5

Discussion Questions:

  1. Create a line graph of the GDP growth rate. Describe what you see.
  2. Explain the effects of a permanent increase in the savings rate on the growth rate of GDP. (hint: compare cases 31, where both cases beganwith the economy in equilibrium but savings increased in case 3)
  3. What doesthis tell you about the stability of the system?

Case 4: Effects of Technological Innovation

Assumptions:

1. Initial Y=1,000

2. Initial K=balanced growth level

3. savings rate = .20 (savings = .2*income)

4. labor growth = .01

5. tech. growth = 0 initially

6. increase tech. growth to .01 in period 5

Discussion Questions:

  1. Create a line graph of the GDP growth rate. Describe what you see.
  2. Explain the effects of a permanent increase in the growth of technological innovation on the growth rate of GDP. (hint: compare cases 4&1, where both cases began with the economy in equilibrium but the growth of technology increased in case 4)
  3. What implications does this have for Real Wages?