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The Solow model

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  1. Introduction
  2. Eisenhower administration
  3. Eisenhower's mandatory
  4. Mutually Assured Destruction (M.A.D.)
  5. Conclusion

Robert Solow was born on August 23, 1924 in New York. He began a course in sociology, anthropology, and economics, which he interrupted to enlist in the U.S. Army in 1942, and subsequently returned to Harvard in 1945. Robert Solow tried to apply his knowledge in statistics and mathematics to macroeconomic problems. He was particularly passionate about the theory of growth, and in 1956 he proposed a new growth model that would revolutionize macro-economy.

In fact, he postulated that an economy may experience stable and sustained growth but it ultimately leads to a steady state. The steady state corresponds to a situation of economic equilibrium with zero growth in production. The level of production in an economy is determined by factors that interact with them. It accounts for the available capital, technical progress and the amount of work present. However, economic growth depends primarily on the growth of population.

Offers are established at an instantaneous equilibrium. The offers with given factors like labor supply is exogenous because it is equal to the existing capital and it takes time to generate additional capital. Factor demands are implicitly expressed by the two relations that equalize marginal productivities of these factors to their costs. The cost of capital is the interest rate plus the depreciation rate. The cost of labor is the real wage.

The equilibrium factor markets are reduced to two relations. It therefore determines the instantaneous levels of wages and interest rates. Production is determined by the amounts of factors available. It only remains to determine the division between consumption and investment. This describes the accumulation of capital which, together with demographic changes, generates the dynamics of the model. The growth path consists of a series of instantaneous equilibrium.

In any neo-classical model, two answers can be made equivalent.
First scheme:
- A property market where price is fixed by agreement with the unit;
- A labor market where price is the real wage;
- A rental market for capital goods which the rent is.

Capital goods are held by households. Savings is directly in the form of purchases of capital goods. The goods are then rented to companies by their owners. The rental market for capital goods is replaced by a financial market. The variables are interrelated to the interest rate. Capital goods are purchased and held by companies that fund these purchases through debt market securities. The money comes from investors who put their savings interest rate and provides the balance of the financial market.

In an economy with perfect markets, these two formulations are equivalent. We can therefore consider that the same variable refers to both the rent of equipment, the real interest rate and (in the absence of risk) the rate of profit. This equivalence is an aspect of the Modigliani-Miller theorem which states that in a perfect market economy, the financial organization does not matter.

Tags: macro-economy, sustained growth, technical progress, capital, financial organization, interest rate, capital goods, labor market, financial market, demographic changes, cost of labor

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