When constant returns to scale are assumed, the Solow Residual is 0. Is this statement correct? Can someone explain the equations how the constant returns to scale affects it? This is the formula i’m referring to: % delta Y = % delta Solow Residual + (a) * % delta K + (1-a) * % delta L
Constant return to scale means that the first term solow residual i.e. Change in TFP is zero
Not sure if this is 100% correct but as I understand this concept: The Solow Residual is a measure of increase in technology. Constant returns to scale means that you are using the same technology base (basically no new innovation) which is why the Solow residual is 0 when assuming this. The only things that affect growth in GDP when technology growth is 0 are capital inputs, and labor inputs.
makes sense, thanks
FinNinja Wrote: ------------------------------------------------------- > Not sure if this is 100% correct but as I > understand this concept: > > The Solow Residual is a measure of increase in > technology. Constant returns to scale means that > you are using the same technology base (basically > no new innovation) which is why the Solow residual > is 0 when assuming this. The only things that > affect growth in GDP when technology growth is 0 > are capital inputs, and labor inputs. According to the schewser video course, TFP cover everything that is not explained by capital and labour, so technology is part of it but not all about it.
------------------------------------------------------- > FinNinja Wrote: > -------------------------------------------------- > ----- > > According to the schewser video course, TFP cover > everything that is not explained by capital and > labour, so technology is part of it but not all > about it. ^ correct. Solow risidual is anything not explained by changes in capital + changes in labor. Technology/productivity changes are just a common example. Constant returns to scale just means changes in capital + changes in labor = change in Yield. In other words the solow residual is zero, change in yield is directly derived from changes in labor and capital.
I do not think constant returns to scale means that solow residual or TFP is zero. All it means is that the capital output elastcity (alpha) and labor out elasticity ( 1- alpha) should be equal to 1. TFP or the residual is explained by growth whioch cannot be attributed either to cpaital input or labor input.
I agree with Veda Essentially - you’re unable to compute TFP in the real world because its intangible or immeasurable, unlike the other inputs or even the output (GDP) Constant returns to scale assumes no change in technology, and that you will attribute the output growth to labour and capital factors, but if there is a residual that cannot be attributed to either of these, that would be the Solow Residual Veda, please correct if I’ve misunderstood
Constant Returns to Scale means: a given percentage increase in capital stock and labor input results in an equal percentage increase in output. This means that if each - capital stock and labor inputs - increase by 5%, their total contribution to the real output will be 5% growth - this is because Beta = 1 - Alpha The Solow Residual (growth in Total Factor Productivity) is not zero for assuming constant returns to scale as shown in CFAI text - solution to 2A - page 183 of Volume 3.
Just as a follow-up to my answer above, Total Factor Productivity can increase even when we assume Constant Returns to Scale as on page 183 of CFAI Volume3.