LIMITATIONS

• The model oversimplifies the sources of economic growth. It only uses capital and savings as determinants. It ignores other factors such as labor productivity and technological advances as factors spurring economic growth. • The model assumes the economy is operating at full employment. That is unrealistic in the real world because the economy often fluctuates around full employment (potential output). These fluctuations produce business cycles in which real GDP rises and falls. • The constant marginal return on capital is not valid. An increase in capital stock actually causes lower returns. The Solow growth model shows you, if the capital per labor ratio is high, the effect of increasing output due to additional capital stock tends to decrease. Thus, capital has a decreasing marginal rate of return