The Solow-Swan model was named after Robert (Bob) Solow and Trevor Swan, or simply after the more famous of the two economists as Solow model. This model is remarkably simple and has also shaped the way we approach economic growth as well as the field of macroeconomics.

Before the advent of the Solow Growth Model, one may fail to appreciate the intellectual breakthrough that it was; as then, the most common approach to economic growth was with reference to the Harrod-Domar model. Solow was successful in demonstrating why the Harrod-Domar model, that emphasized potential dysfunctional aspects of economic growth, for example, how unemployment and economic growth go hand in hand, was an unattractive place to start.

An important

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It postulates a continuous production function linking to the inputs of capital and labor which leads to the steady state equilibrium of the economy.

Solow’s twist on the Harrod-Domar model is based on the law of diminishing returns to individual factors of production. Capital and labor go together in order to produce output. If there is plenty of labor relative to the capital, a little bit of capital will go a long way. Conversely, if there is a shortage of labor, capital intensive methods are used at the margin and and the incremental capital-output ratio rises.

The Solow Growth model actually represents capital accumulation in a pure production economy with no prices because we tend to be strictly interested in output=real income. Assuming that all people work all the time, we assume they save and hence invest, a fixed portion of their income. As there is no government, so there are no taxation and subsidies; this is a closed economy, so there is no trade. Since there are no prices, there is no need for money: there are no financial

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Therefore, the Solow model studies a situation where the capital-output ratio changes with the per capita availability of capital in the economy, the change being driven by the principle of diminishing returns, so that a higher per capita stock raises the capital-output ratio.

Particularly Solow model tells us that parameters such as the savings rate have only level effects, in contrast to the growth effects of savings in Harrod-Domar model. Indeed in the simple version, there is a steady state level of per capita income to which the economy must converge. It also infers that irrespective of the initial capital per capita capital stock, two countries with similar saving rates, population growth rates and depreciation rates will converge to similar standards of living in the “long run”.

Success of Solow growth model

1. Investment, per capita income graph

The Solow model makes a prediction that if a nation devotes a larger fraction of its income to savings (and therefore investment), it will have a higher steady-state capital stock and a higher steady-state level of per-capita