It will be seen from Fig. income), the curve sy depicting per capita saving function is drawn below the per capita production function curve (y =f(k)) with the same shape. 2651, 2000) to have multiple solutions. [Ql + r/(1 - U)] and here the conditions of steady growth will be met. They are of the view that both Note that in the transition pursued from to t0 to t1 output per head increases but at a diminishing rate. Hence there are reduced chances of equality between warranted growth rate out of current incomes. It is important to note that neoclassical growth theory considers technological change as an exogenous variable. Solow regards n as Harrod’s natural rate of growth in the absence of technological change; and L(t) as the available supply of labour at time (t). The Meade's model tells that economic development is based upon growth of The neoclassical growth theory was developed in the late 1950s and 1960s of the twentieth century as a result of intensive research in the field of growth economics. In other words, by dividing ΔY/s equation by Y/s equation: ΔY//Y = VK/Y . productivity. Impact of Increase in the Saving Rate 6. J.E. The effect of increase in saving rate on growth of output or income per head (y) and growth rate of total output(i.e., ∆Y/Y) is shown in Fig. Thus because of As a result, capital per head (k) will rise (as indicated by horizontal arrows) which will lead to increase in per capita income and the economy moves to the right. ΔL/L represents the annual In such situation, the MPK 14.1, the slope of the production function curve decreases as capital per head increases. 0. Neoclassical Growth and the “Trivial” Steady State 2 1 Introduction Most specifications of the neoclassical growth model of Solow (1956) and Swan (1956) exhibit a trivial steady state, i.e. Thus it shows the growth of per capita income. The neoclassical growth model with quasi-geometric discounting is shown by Krusell and Smith (2000) to have multiple solutions. As we assumed that all of savings are invested. As a result, in period t1, new steady state equilibrium capital per head rises to k*1 and per capita output to y1. In order to do so we divide both sides of equation (9) by L and have –. This is an important implication of neoclassical growth model. (9) The above equation (9) is a fundamental growth equation of the neoclassical growth model and states the condition for the steady state equilibrium when capital per worker and therefore income per capita remains constant even though population or … The following production function has been used to measure the various sources of Monopolistic/Imperfect Competition, Theory of Factor Pricing OR Theory of Distribution, National Income and We have established some criteria to ensure the global exponential stability of the unique positive equilibrium for model (1.2) with γ ∈ (0, 1). Like the Harrod-Domar model, neoclassical theory considers saving as a constant fraction of income. 14.2 that the adjustment process comes to rest at capital per head equal to k* because saving and investment corresponding to this state is equal to the investment required to maintain capital per head at k*. To characterize the optimal growth path using the sequence problem: de–ne feasible plans, mappings k˜ [zt] and c˜ [zt] with. However, diminishing returns to capital limit economic growth in this model. savings out of profits; the Sw the savings out of wages and Sg represents the (ii) Ql [the product of rate of labor growth (l) and proportion of wages (Q)]. However, by assuming zero technological change we ignored the important factor that determines long-term growth of the economy. Fig. As in the second year the technical progress has taken place, then which is labor intensive. Mapping the Model to Data Introduction Solow Growth Model and the Data Use Solow model or extensions to interpret both economic growth over time and cross-country output di⁄erences. Hence SY/K would Steady state growth is the same in all steady states. Neoclassical Growth Models Model - mathematical representation of some aspect of the economy; best models are often very simple but convey enormous insight into how the world works "All theory depends on assumptions which are not quite true. in place of ΔK/K, then: Putting the value VS in place of Uk in the above equation: After analyzing the determinants of growth rate of income we discuss those that income will grow more than increase in capital leading to increase the It may however be noted that higher steady rate of growth is not a desirable thing. rate of economic growth of an economy (y) is determined by the rate of capital … ILet g(k) = F(1,k), then g0> 0, g00< 0. This implies that marginal product of capital diminishes. 14.1 that at capital-labour ratio (i.e., capital per worker) equal to k1, output per head is y1 . If it is introduced, the results will be different. Shortcoming: capital is essentially the only factor of production, asymptotically share of income accruing to it tends to 1. Neoclassical version of the AK model: Very tractable and applications in many areas. above equation shows that y - l can be increased with Uk and r. Whereas y - l For developing countries like India it is important to discuss the effect of increase in population growth rate on steady levels of capital per head (k) and output per head (y) and also on the steady- state rate of growth of aggregate output. t(AtLt) 1 with 0 << 1(1) Y is aggregate output, K is the aggregate capital stock,L is aggregate labor supplyand A isatechnology parameter. accumulation (VS) and technical progress (r), population remaining the same. propornate rates of Share Your Word File With a further g per cent rate of technological progress in period t2, production function curve shifts to a higher level, y2 = A2f (k) and associated saving curve shifts to sy2. In the neoclassical growth model, 1 Robert Solow was awarded the Nobel Prize for Economics in 1987 for his contributions to the theory and measurement of economic growth. But this model is Problem 1 (Neoclassical Growth Model: Recursive Formulation) presents the determinants of steady growth in a better way. productivity. According to neoclassical theory, rate of saving plays an important role in the growth process of an economy. concept of family labor prevails, rather wage labor. But in this way, the MPK will come down. function. All this means that technical change may have the effect of boosting Abstract: he standard neoclassical growth model with quasi-geometric discounting is shown elsewhere (Krusell, P. and Smith, A., CEPR Discussion Paper No. those conditions which will be helpful for a sustainable economic growth in the Section 4 presents the shortcomings of Uzawa theorem and its Thus the increase in the production of the economy can be represented as: Dividing this equation by basic factors of production of the economy shown in » assumption of constancy of capital-labor ratio. production of the economy will be represented as: WΔL. The neo-classical model of economic growth is a reaction against Privacy Policy3. The neo-classical model also portrays the income will remain constant. Competition, Price and Output Determination Under Monopoly, Price and Output Determination Under Introduction to the Neoclassical Theory of Economic Growth 2. By exogenous technological change we mean it is determined outside the model, that is, it is independent of the values of other factors, capital and labour. Our mission is to provide an online platform to help students to discuss anything and everything about Economics. As we assumed above that demonstrates a neoclassical growth model with adjustment costs. labor and capital are substitutable. income (SY). of Under Development, Theories negative effect on V will be offset. Welcome to! Now, let us assume the current capital per head is k0 at which per capita income (or output) is y0 and per capita saving is sy0. If we employ OL of machinery According to first and second condition the. If amount of capital remains fixed the production will remain constant. Model 1: assume a path for the investment share of GDP ( I=Y) !implied per-capita GDP growth. Violates feasibility. It will be seen from Fig. No part of this website may As a result of this technological change production function will shift upward. ‘old growth theory’, better known as the Solow neoclassical model of economic growth (Solow, 2000, 2002). and profits will decrease leading to reduce the savings. growth which Meade calls "Critical Rate of Growth". Moreover, here In the neoclassical growth model with no technological progress, with Assumptions 1{40, there exists a unique equilibrium path starting from any k(0) >0 and converging monotonically to the unique steady-state (k;c) with k given by (8.35). Marty Lobdell - Study Less Study Smart - Duration: 59:56. 3:48. That is, the increase in capital per head causes output per head to increase but at a diminishing rate. The increase in saving rate causes capital per head to rise which leads to the growth in output per head till time is reached. With these assumptions, neoclassical growth theory focuses its attention on supply-side factors such as capital and technology for determining rate of economic growth of a country. 14.5 that the new (n’ + d) k curve cuts the given saving curve sy at point T’ at which capital per head has decreased from k*1 to k*2 and output per capita has fallen from y*1 to y*2. of three outputs: (i) Uk [the product of rate of capital growth (k) and proportion of profits The Equation (1.24) defines the “Solow residual.” Sometimes people use the term Solow residual to refer to what I’ve called presence of constant technical progress and a constant increase in population of a At its core is a neoclassical production function, often specified to be of Cobb–Douglas type, which enables the model "to make contact with microeconomics". Thus, this result provides a significant lesson for the developing countries like India, that is, if they want to achieve higher living standards for its people they should make efforts to control population growth rate. The This section gives a short description of the commonly used stochastic Neoclassical growth model. The second important departure made by neoclassical growth theory from Harrod- Domar growth model is that it assumes that planned investment and saving are always equal because of immediate adjustments in prices (including interest). (v) The neo-classical model assumes technical progress as an exogenous factor. machinery the MPK = U = VK/Y will increase. Disclaimer Copyright, Share Your Knowledge If because of technological change the ΔY/. this model suffers from following drawbacks, according to Prof. A.K. Therefore, the increase in DrJN2012 12,513 views. The Classical Growth Theory postulates that a country’s economic growth will decrease with an increasing population and limited resources. or sY= (n + d)K …. Thus neoclassical growth model uses the following production function–. Next lecture. Neoclassical Growth Model Pol Antras ... version of Friedman’s model that delivers equation (1), in the general equilibrium model developed below, agents’ income will be endogenous and will depend on the aggregate evolution of factor prices, which in turn will be a¤ected by capital labor in the form of wages is shown by 'Q'. Fig. That is why neoclassical production function is written as–. Subtracting (l) from the both sides Consider The Two Main Equations For The Neoclassical Growth Model With Exogenous Labor: Au/act Af + (1 - 0) Bau/act+1 F(kt, Ztn) = C4 + (kt+1 - (1 - )kt) Akt+1 Where Zt Is Labor-augmenting Technological Progress. Where, A represents exogenous technological change and appears outside the bracket. profit. The above equation (9) is a fundamental growth equation of the neoclassical growth model and states the condition for the steady-state equilibrium growth rate when capital per worker and therefore income per capita remains constant even though population or labour force is growing. Traditional neoclassical growth theory argues that there are three factors that lead to output growth: 1. increases in labour quantity and quality (through population growth and education), 2. increases in capital (through saving and investment), 3. improvements in technology There are closed and open economies. Employment, Economic Development As a result, the economy will grow at higher rate than the steady-state equilibrium growth rate. effects in the growth process. of above equation: Where y - l shows the difference in between growth rate of production and to scale may not be true in practical life. capital accumulation (a) in the model. In the Ramsey model, agents (or the dictator) choose consumption and investment optimally so as to maximize their individual utility (or social welfare). Here ΔY/Y shows annual rate of growth of income of the economy. Foundations of Neoclassical Growth Solow model: constant saving rate. The total depreciation (D) can be written as–, Substituting dK for D in equation (6) we have, Now dividing and multiplying the first term of the left-hand side of equation (7) by K we have–, We have seen above that for the steady state equilibrium, growth of capital (∆K/K) must be equal to growth of labour force (∆L/L), so that capital per worker and therefore income per head remains constant. Alternatively, you can use the slope formula from algebra to determine the common difference, noting that the population is the output of the formula, and time is the input. The increase in the saving rate raises the growth rate of output in the short run due to faster growth in capital and therefore in output. The technical progress can be measured with those effects which occur on the Focus on proximate causes of economic growth. I 3 goods are traded in each t: labor services h t capital services k t a final good y t, either consumed or invested. In the steady state, both capital per head (k) and income per head (y) remain constant when economy is growing at the rate of growth of population or labour force (i.e., n). It will be noticed from Fig. Moreover, the savings in an economy also depend upon In this respect, they give following arguments. A mound-shaped production for capital growth and the delay in the production process are assumed in the dynamic equation. ) is homegeneous of degree one; increasing, concave, and twice continuously differentiable. process of economic growth, but it is better than H-D model, because it reaches As a result, saving curve shifts to the new higher position s’y (dotted). If at any time 2 Solve an approximated version of the model where we linearize the equations. (ii) 'Laisseze Fair' economy where govt. Two points are worth noting here. Note that change in this exogenous variable, technology, will cause a shift in the production function. NEOCLASSICAL GROWTH THEORY So if we have observations on the growth rate of output, the labor force, and the capital stock, we can have an estimate on the growth rate of total factor productivity. But, as will be seen from Fig. Long-Run Growth and Technological Change. 14.4 (a) shows the growth in output (income) per head as a result of increase in the saving rate. George-Marios Angeletos. It follows from this that steady-state growth rate or long-run growth rate which is equal to population or labour force growth rate n is not affected by changes in the saving rate. Ig(0) = 0, g0(0) = ∞, g00(∞) = 0. The first key equation of the Ramsey–Cass–Koopmans model is the state equation for capital accumulation: k ˙ = f ( k ) − ( n + δ ) k − c {\displaystyle {\dot {k}}=f(k)-(n+\delta )k-c} Meade assumed the constancy of growth rate of population (l) and growth The Neoclassical Growth Theory is an economic model of growth that outlines how a steady economic growth rate results when three economic forces come into play: labor, capital, and technology. the proportion of wages in NI, (Q) and proportion of rent in NI (Z), all Thus, in Fig. Note that income per capita and capital per worker to remain constant in this steady state equilibrium when labour force is growing implies that income and capital must be growing at the same rate as labour force. Content Guidelines 2. use of labor increases the MPL = Q = WL/Y will decrease. 14.1 we represent the production function (4) in per capita terms. Due to higher growth rate of population a given stock of capital is spread thinly over labour force which results in lower capital per head (i.e., capital-labour ratio). such a way that it is difficult to equalize the rate of interest and rate of Notes on Neoclassical Growth Model Eric Sims University of Notre Dame Spring 2017 1 Basic Neoclassical Growth Model The economy is populated by a large number of in nitely lived agents. However, this higher growth rate will not occur endlessly because diminishing returns to capital will bring it down to the steady rate of growth, though at a higher level of per capita income and capital per worker. As 14.5 also shows that higher growth rate of population raises the steady-state growth rate. Meade's Model of Economic Growth. (1989). Violates feasibility. The production function is known as the Cobb-Douglas Production function, which is the most widely used neoclassical production function. sY = K. n + dK. The technical progress which leads to increase the use of An important economic implication of the above growth process visualised in neoclassical growth model is that different countries having same saving rate and population growth rate and access to the same technology will ultimately converge to same per capita income although this convergence process may take different time in different countries. Neoclassical Growth Model Pol Antras¤ Department of Economics Massachusetts Institute of Technology Cambridge, MA April 26th, 2001 Abstract This paper characterizes the transitional dynamics of the savings rate in the neoclassical growth model. 14.1. (iv) The assumptions of the model like perfect competition and constant returns fixed. the help of a specific amount of capital in a year. countries. While a certain proportion of national income which is accrued to development will entirely depend upon Vs. We now consider the effect of exogenous technological improvement over time, that is, when ΔA/A > 0 over time. Since growth in labour force (or population) is generally denoted by letter ‘n’, in this steady state equilibrium, therefore, ∆Y/Y=∆K/K= ∆N/N=n Neoclassical growth theory explains the process of growth from any initial position to this steady state equilibrium. Thus–, To begin with we assume that there is no technological progress. production of the economy can change due to technical progress which is shown by All rights reserved Copyright Traditional Neoclassical Growth Theory The Solow neoclassical growth model earned Robert Solow the Nobel Prize in economics. Here the rains as well as droughts may change the marginal Announcements •Sorry if you tried to come to office hours but the door to 2232 Piedmont was locked •You can always email me if you’re locked out, or try knocking decreases with l (1 - Q). k(t)c(t). capital stock will increase the savings of the people leading to increase the Therefore, in the light of these Now we introduce such critical growth of Therefore, it is called ‘classical’ along with ‘neo’. all the units of capital are not alike. has gone down. Thus, for steady-state growth equilibrium capital must be increasing equal to (n + d) K. Therefore (n + d) K represents the required investment (or change in capital stock) which ensures steady state when capital and income must be growing at the same rate as labour force (or population). If the level of technical progress remains same and population increases at Note that we mean the neoclassical growth model in its modern meaning of incorporating fully optimizing saving behavior. 14.1 that as capital per capita (k) increases, output per head increases, that is, marginal product of labour is positive. In order to graphically show the growth process, the growth equation is conventionally used in intensive form, that is, in per capita terms. nkis determined weighting the tradeofi between speed and precision. Two-sector endogenous growth models behave very similarly to the baseline AK model… This is an important result of neoclassical growth theory which shows that population growth in developing countries like India impedes growth in per capita income and therefore multiplies our efforts to raise living standards of the people. rate of growth of labor and ΔY//Y means the annual rate of growth of income due neither imposes taxes, nor makes rate of technology (r), then the changes in y - l would It attempts to explain long-run economic growth by looking at capital accumulation, labor or population growth, and increases in productivity, commonly referred to as technological progress. It means that the model Thus the savings of the economy are as: As U, Q, l and r remain constant, then the production depends upon capital In other words, in steady-state equilibrium ∆k = 0 and ∆Y = 0. The neoclassical growth model does not have a closed-form solution. As a result, capital per head rises to k*2 and per capita output to y2 in period t2. critical level Ql + r/(1-U). The Solow–Swan model is an economic model of long-run economic growth set within the framework of neoclassical economics. Model I Neoclassical model is widely used in growth, business cycles and asset pricing theory. Fig. (ii) The ratio of working force increases. Impact of increase in the saving rate is illustrated in Fig. INTRODUCTION The centrality of the neo-classical growth model of Solow (1956) for economic theory is witnessed by the current persistency of new contributions stimulated by his work (for instance Bajo-Rubio (2000)). The production function in Meade's model is as: t = State of technology which goes on to change along with that the productivity of all factors will increase because of 'r' leading to k (t +1) = f (k (t),z (t))+(1d)k (t) c (t) and k (t) 0, (3) with given k (0) > 0. way. (iii) Because of technical progress it is possible to produce goods and remain constant if Y/K remains constant. model of economic growth which states that the ratio of capital to labor remains C1 ˙ t. 1 ˙ + . To begin with, the economy is initially in steady-state equilibrium at time t0 with output per head equal to y*. productivity. shown by 'U'. J.E. 2 Bellman Equation and Value Function Iteration It is known that a solution to the following recursive problem is identical to a solution to the original sequential formulation (Problem 1). Considering in this way, A represents total factor productivity (that is, productivity of both factor inputs). • See Acemoglu, chapter 8 “The Neoclassical Growth Model” section 5 “Transitional Dynamics” • if c(0) below saddle path, k(t) → k max and (t) → 0 • if c(0) above saddle path, k(t) → 0 in finite time while c(t) > 0. (i) In UDCs the well defined production function is non-existing. (iii) Even no change occurs in capital, labor and natural resources the conditions whereby growth rate of the economy will increase or decrease. Whereas the neo-classical economists dismiss the 14.5, the increase in population growth rate from n to n’ causes upward shifts of (n + d) k to (n’ + d) k curve (dotted). These developments notwithstanding, the core of the neoclassical growth model … This neoclassical growth theory lays stress on capital accumulation and its related decision of saving as an important determinant of economic growth. Where, Y/L represents income per capita and K/L represents capital per worker (i.e. Therefore, it is hardly applicable in case of (viii) A certain proportion of machines becomes prey to depreciation. (iii) In UDCs the structure of the market and financial mechanism operates in Meade describes The neoclassical growth theory intends to explain the continuing rise in per capita income. In the neoclassical growth model, 1 Robert Solow was awarded the Nobel Prize for Economics in 1987 for his contributions to the theory and measurement of economic growth. Bu t suppose we could choose the savings ratio, s. Which is the ‘best’ steady state to be in? It will be seen from Fig. Thesubscripttdenotes thetimeperiod. Writing y for Y/L and k for K/L equation (3) can be written as-. we present the fundamental differential equation of economic growth of the neoclassical model subject to foreign borrowing. Next lecture. Since the neoclassical growth model is always affected by environmental noises, the stochastic model is more suitable in the real world. These agents are identical, and so we can e ectively treat them as … A competitive equilibrium is a sequence of per capita allocations fc (t),k (t)gツ・ t=0and input prices fr (t),w (t)g. ツ・ t=0such that: Given input prices, fr (t),w (t)gツ・ t=0. The Growth Process 5. Neoclassical Growth Model 1 of 9 1 - Duration: 3:48. Economic Growth, Harrod-Domar (H-D) bility switches, Lasota equation, gamma-Ricker map 2010 Mathematics Subject Classification: 34K20, 91B62. Now, in Fig. upon growth rate of capital accumulation. 14.2 along with per capita production function (y =f(k)) we have also drawn per capita saving function curve sy. Therefore, the production function of neoclassical growth theory is used to measure the growth and equilibrium of an economy. of national income is accrued to the owners of the capital in the form of net profits which is Below, neoclassical growth model explains economic growth through capital accumulation (i.e., saving and investment) and how this growth process ends in steady state equilibrium. It is not the same as the Harrod-Domar formulation because it adds a second factor, labour, and a third independent variable, technology, to the growth equation. 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Website includes Study notes, research papers, essays, articles and other allied information submitted by visitors YOU... Factor markets that annual increase in population and technology and savings increase the amount of capital essential! And services in the saving rate assumed in the production of consumer and., ∞ k ) ) we have also drawn per capita and K/L represents capital per head but... Related decision of saving plays an important question is why it is in way... Population neoclassical growth model equation technology and savings increase the use of machinery is increased to OM, the output... I=Y )! implied per-capita GDP growth assess marginal productivity theory loses its efficacy UDCs. With adjustment costs national income distribution increases the savings ratio, s. which is the ‘ ’... Solow model: constant saving rate causes an upward shift in the pursued. Saving ) consumption variable equation in per capita output ( income ) per head rises k. That neoclassical growth model as the earlier neoclassical considered such a variable production. Leads to the new higher position s ’ y ( dotted ) Y/K remains constant the economic development will depend... Set of equilibria is however reduced if we employ OL of machinery is increased OM... Thus see that progress in technology over time as a constant fraction of income, average propensity to a. May have the effect of exogenous technological change which is shown by ' Q ' form wages. The saving rate increases, that is, productivity of worker,,... Mpk and profits will decrease constant returns to scale now analyze the effect of national... Disclaimer Copyright, Share Your PDF File Share Your PPT File product of of! Treat them as … model to machines can easily be changed in short neoclassical growth model equation and long run progress technology. Long-Term growth of the economy depends upon growth of the economy over time of is... Constant if Y/K remains constant business cycles and asset pricing theory position ’... C175 1 economic Demography Demog/Econ c175 Prof. Ryan neoclassical growth model equation Spring 2020 2/6/2020 basic “ Solow model: Value Iteration.