the theory of economic growth
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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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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?
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
slide6
“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 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 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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