The Economic Growth, Model of Solow

The economic growth model best known is the economic growth model of Solow, also called neo-classical economic growth model.

The economic growth model of Solow is based on a neoclassical production function in which the product depends on the combination of labor and capital, and uses the typical neoclassical assumptions - decreasing
marginal productivity, perfect competition, etc .- and its main conclusion is that savings will reach a steady state in which per capita output growth is zero. The production level steady state depends on the production function, ie, technology, and factor endowments. However, in the steady state capital increases the rate of population growth, and so does production. Therefore, per capita output remained unchanged. The technology does not evolve over time. This occurs because the assumption of perfect competition in all markets eliminates the potential gains from technological upgrading, so there is no incentive to invest in technology and resources to that investment (payments to factors exhaust all income).

The golden rule of economic growth tells us that the optimal savings rate is one that maximizes the consumer. With a lower savings rate, consumption may increase because higher savings lead to greater investment, more capital and higher output. However, a higher saving rate implies a higher capital stock so that much of the income must be used to fund the depreciation of capital and can not use it for consumption.