Taking Stock
This chapter presented arguably the most important model in macroeconomics; the one- sector neoclassical growth model. Recall that our study of the basic models of economic growth started in Chapter 2, with the Solow growth model.
We saw that while this model gives a number of important insights, it treats much of the mechanics of economic growth as a “black box”. Growth can only be generated by technological progress (unless we are in the special AK model without diminishing returns to capital), but technological progress is outside the model. The next important element in determining cross-country differences in income is the saving rate, but in the Solow growth model this was also taken as exogenous. The major contribution of the current chapter has been to open the black box of capital accumulation by specifying the preferences of consumers. Consequently, we can link the saving rates to the instantaneous utility function, to the discount rate and also to technology and prices in the economy. Moreover, as Exercise 8.23 shows the implications of policy on equilibrium quantities are different in the neoclassical model than in the Solow growth model with exogenously given saving rates.Another major advantage of the neoclassical growth model is that by specifying individual preferences we can explicitly compare equilibrium and optimal growth.
Perhaps the most important contribution of this model is that it paves the way for further analysis of capital accumulation, human capital and endogenous technological progress, which will be our topic in the next few chapters (starting with human capital in Chapter 10). Therefore, this chapter is the first, and perhaps conceptually most important, step towards opening the black box of economic growth and providing us with the tools and perspectives for modeling capital accumulation, human capital accumulation and technological change endogenously.
Did our study of the neoclassical growth model generate new insights about the sources of cross-country income differences and economic growth relative to the Solow growth model? The answer here is largely no. While the current model is an important milestone in our study of the mechanics of economic growth, as with the Solow growth model, the focus is on the proximate causes of these differences—we are still looking at differences in saving rates, investments in human capital and technology, perhaps as determined by preferences and other dimensions of technology (such as the rate of labor-augmenting technological change). It is therefore important to bear in mind that this model, by itself, does not enable us to answer questions about the fundamental causes of economic growth. What it does, however, is to clarify the nature of the economic decisions so that we are in a better position to ask such questions.
8.12.
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