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The Theory of Economic Growth. Questions. How important is faster labor-growth as a drag on economic growth? How important is a high saving rate as a cause of economic growth? How important is technological and organizational progress for economic growth?

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The Theory of Economic Growth

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The theory of economic growth

The Theory of Economic Growth


Questions

Questions

  • How important is faster labor-growth as a drag on economic growth?

  • How important is a high saving rate as a cause of economic growth?

  • How important is technological and organizational progress for economic growth?

  • How does economic growth change over time?

  • Are there economic forces that will allow poorer countries to catch up to richer countries?


American real gdp per capita 1800 2004 in 2004 dollars

American Real GDP per Capita, 1800-2004 (in 2004 Dollars)


Long run economic growth

Long-Run Economic Growth

  • We classify the factors that generate differences in productive potentials into two broad groups

    • differences in the efficiency of labor

      • how technology is deployed and organization is used

    • differences in capital intensity

      • how much current production has been set aside to produce useful machines, buildings, and infrastructure


The efficiency of labor

The Efficiency of Labor

  • The efficiency of labor has risen for two reasons

    • advances in technology

    • advances in organization

  • Economists are good at analyzing the consequences of advances in technology but they have less to say about their sources


The theory of economic growth

“1974”

  • There was a slowdown in productivity growth from approximately 1974 to around 1990.

  • This is associated with the ITC (information and communications technology) ‘revolution’.

  • Slowdown causes:

    • Measurement – inadequate accounting for quality improvements

    • The legal and human environment – regulations for pollution control and worker safety, crime, and declines in educational quality.

    • Oil prices – huge increases in oil prices reduced productivity of capital and labor, especially in basic industries

  • Kondratiev cycles

    • 1873-1890 steam power, trains, telegraph

    • 1917-1927 electrification in factories

    • 1948-1973 transistor


Capital intensity

Capital Intensity

  • There is a direct relationship between capital-intensity and productivity

    • a more capital-intensive economy will be a richer and more productive economy


Standard growth model

Standard Growth Model

  • Also called the Solowgrowth model

  • Consists of

    • variables

    • behavioral relationships (aka laws of motion)

    • equilibrium conditions

  • The key variable is labor productivity

    • output per worker (Y/L)


Solow growth model

Solow Growth Model

  • Balanced-growth equilibrium

    • the capital intensity of the economy (K/Y) is stable

      • This necessitates that the economy’s capital stock and level of real GDP are growing at the same rate

    • the economy’s capital-labor ratio is constant


Solow growth model1

Solow Growth Model

  • After finding the balanced-growth equilibrium, we calculate the balanced-growth path

    • if the economy is on its balanced-growth path, the present value and future values of output per worker will continue to follow the balanced-growth path

    • if the economy is not yet on its balanced-growth path, it will head towards it


The production function

The Production Function

  • The production function tells us how the average worker’s productivity (Y/L) is related to the efficiency of labor (E) and the amount of capital at the average worker’s disposal (K/L)

  • Cobb-Douglas production function


The production function1

The Production Function

  •  measures how fast diminishing marginal returns to investment set in

    • the smaller the value of , the faster diminishing returns are occurring


The cobb douglas production function for different values of

The Cobb-Douglas Production Function for Different Values of 


The production function2

The Production Function

  • The value of the efficiency of labor (E) tells us how high the production function rises

    • a higher level of E means that more output per worker is produced for each possible value of the capital stock per worker


The cobb douglas production function for different values of e

The Cobb-Douglas Production Function for Different Values of E


The production function example

The Production Function: Example

  • E = $10,000

  •  = 0.3

  • K/L = $125,000


The production function example1

The Production Function: Example

  • If K/L rises to $250,000

  • the first $125,000 of K/L increased Y/L from $0 to $21,334

  • the second $125,000 of K/L increased Y/L from $21,334 to $26,265


Saving investment and capital accumulation

Saving, Investment, and Capital Accumulation

  • The net flow of saving is equal to the amount of investment

  • Real GDP (Y) can be divided into four parts

    • consumption (C)

    • investment (I)

    • government purchases (G)

    • net exports (NX = X - M)


Saving investment and capital accumulation1

Saving, Investment, and Capital Accumulation

  • The right-hand side shows the three pieces of total saving

    • household saving (SH)

    • government saving (SG)

    • foreign saving (SF)


Saving investment and capital accumulation2

Saving, Investment, and Capital Accumulation

  • Let’s assume that total saving is a constant fraction (s) of real GDP

  • Therefore, it must be true that


Saving investment and capital accumulation3

Saving, Investment, and Capital Accumulation

  • We will refer to s as the economy’s saving rate

    • we will assume that it will remain at its current value as we look far into the future

    • s measures the flow of saving and the share of total production that is invested and used to increase the capital stock


Saving investment and capital accumulation4

Saving, Investment, and Capital Accumulation

  • The capital stock is not constant

  • We will let

    • K0 will mean the capital stock at some initial year

    • K2014 will mean the capital stock in 2014

    • Kt will mean the capital stock in the current year

    • Kt+1 will mean the capital stock next year

    • Kt-1 will mean the capital stock last year


Saving investment and capital accumulation5

Saving, Investment, and Capital Accumulation

  • Investment will make the capital stock tend to grow

  • Depreciation makes the capital stock tend to shrink

    • the depreciation rate is assumed to be constant and equal to 


Saving investment and capital accumulation6

Saving, Investment, and Capital Accumulation

  • Next year’s capital will be

  • The capital stock is constant when


Saving investment and capital accumulation7

Saving, Investment, and Capital Accumulation

  • Suppose that the economy has no labor force growth and no growth in the efficiency of labor

    • if K/Y < s/, depreciation is less than investment so K and K/Y will grow until K/Y = s/

    • if K/Y > s/, depreciation is greater than investment so K and K/Y will fall until K/Y = s/


Saving investment and capital accumulation8

Saving, Investment, and Capital Accumulation

  • Thus, if the economy has no labor force growth and no growth in the efficiency of labor, the equilibrium condition of this growth model is


Equilibrium with just investment and depreciation

/s

Equilibrium

K/L

Equilibrium with Just Investment and Depreciation

(the reciprocal of the

capital-output ratio)

Output

per Worker

(assumes that

 and E are constant)

The capital stock

is growing because

K/L > /s

The capital stock

is shrinking because

K/L < /s

Capital Stock per Worker


Saving investment and capital accumulation9

Saving, Investment, and Capital Accumulation

  • Remember that, in this particular case, we are assuming that

    • the economy’s labor force is constant

    • the economy’s equilibrium capital stock is constant

    • there are no changes in the efficiency of labor

  • Thus, equilibrium output per worker is constant

  • Now we will complicate the model


Steady states

Steady States

  • Steady state: yt, ct, and kt are constant over time

  • Gross investment must

    • Replace worn out capital

    • Expand so the capital stock grows as the economy grows, nKt

  • It = (n + d)Kt

  • Ct = Yt – It = Yt – (n + d)Kt

  • c = f(k) – (n+d)k


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