The Solow Model and Ideas

[Alex] We've covered a lot
of the Super Simple Solow Model.

We've looked at
the dynamics of capital accumulation,

how changes in savings rates
influence growth,

and we've looked look at some of the
predictions of the Solow Model.

One thing we've learned is that
the model seems to inevitably predict

that we end up in a steady state
with no growth.

Now, however, we're going to turn
to the last of our variables: Ideas.

Can ideas keep us growing?

Better ideas mean
that we get more bang for our buck,

more output from the
same inputs of capital and labor.

Alternatively, we can think about
this as increasing our productivity.

Henry Ford, for example, took ideas
from lots of other industries,

like meatpacking, bicycle making, and brewing,

and he combined them in a way

that had never before been used in
the manufacturing of automobiles.

This novel combination of ideas
sparked a dramatic increase in productivity

that transformed the world.

The same types of processes -
they're continuing today,

and in all industries, increasing output per
worker across the economies.

So let's go back to our previous
graph of capital and output.

We can now add ideas as a multiplier.

Better ideas multiply the
output from the same capital stock.

So, if A increases from 1 to 2,

that's a doubling of our productivity.

And that shifts the output curve up.

When output doubles, so does investment.

Now, once again, investment
is greater than depreciation.

So we begin accumulating capital
once again.

And that further boosts our output.

So better ideas spur more output,

which creates more investment,

which leads to capital accumulation.

So better ideas lead to growth in two ways:

The increased productivity of a given capital stock,

and the increased investment,
which increases capital accumulation.

Now imagine that ideas
are constantly improving.

You'd have continual shifts
upward of the output curve.

And that means continual
shifts upward of the investment curve.

We'd always stay to the left of
the steady state,

and there, we'd continually grow.

So growth at the cutting edge -

it's determined by how fast new ideas are formed,

and how much those new ideas increase our productivity.

So that's our Super Simple Solow Model.

It combines a model of catching
up growth due to capital accumulation,

with a model of cutting edge growth
due to idea accumulation.

If you want to dive further into the Solow Model,

check out our textbook, "Modern Principles."

We also have more material in our
Development Economics course.

In that course,
we'll add population growth to the model.

and dive deeper into the data
to see how well the model predicts.

We'll find some things it predicts really well,

and other things not so much.

Finally, since ideas drive growth
on the cutting edge,

we'd like to know what factors help
to spur the creation of new ideas.

This topic is a personal favorite of mine,

and it's up next.

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