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Economic Growth. The World Economy. Total GDP: $31.5T GDP per Capita: $5,080 Population Growth: 1.2% GDP Growth: 1.7%. The World Economy by Region. United States GDP: $10.1T GPD/Capita: $35,500 Pop Growth: .9% GDP Growth: 2.1%. European Union GDP: $6.6T GDP/Capita: $20,230

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The world economy l.jpg
The World Economy

  • Total GDP: $31.5T

  • GDP per Capita: $5,080

  • Population Growth: 1.2%

  • GDP Growth: 1.7%



Us vs europe l.jpg

United States

GDP: $10.1T

GPD/Capita: $35,500

Pop Growth: .9%

GDP Growth: 2.1%

European Union

GDP: $6.6T

GDP/Capita: $20,230

Pop Growth: .2%

GDP Growth: .7%

US vs. Europe


High income vs low income countries l.jpg
High Income vs. Low Income Countries

  • As a general rule, low income (developing) countries tend to have higher average rates of growth than do high income countries



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High Income vs. Low Income Countries

  • As a general rule, low income (developing) countries tend to have higher average rates of growth than do high income countries

  • However, this is not always the case


Exceptions to the rule l.jpg

Haiti

GDP/Capita:$440

Pop Growth: 1.8%

GDP Growth: -.9%

Hong Kong (China)

GDP/Capita: $24,750

Pop Growth: .8%

GDP Growth: 2.3%

Exceptions to the Rule


High income vs low income countries9 l.jpg
High Income vs. Low Income Countries

  • As a general rule, low income (developing) countries tend to have higher average rates of growth than do high income countries

  • However, this is not always the case

  • So, what is Haiti doing wrong? (Or, what is Hong Kong doing right?)


Sources of economic growth l.jpg
Sources of Economic Growth

  • Recall, that we assumed three basic inputs to production

    • Capital (K)

    • Labor (L)

    • Technology (A)


Growth accounting l.jpg

Step 1: Estimate capital/labor share of income

K = 30%

L = 70%

Growth Accounting


Growth accounting12 l.jpg

Step 1: Estimate capital/labor share of income

K = 30%

L = 70%

Step 2: Estimate capital, labor, and output growth

%Y = 5%

%K = 3%

%L = 1%

Growth Accounting


Growth accounting13 l.jpg

Step 1: Estimate capital/labor share of income

K = 30%

L = 70%

Step 2: Estimate capital, labor, and output growth

%Y = 5%

%K = 3%

%L = 1%

Productivity growth will be the residual output growth after correcting for inputs

Growth Accounting


Growth accounting14 l.jpg

Step 1: Estimate capital/labor share of income

K = 30%

L = 70%

Step 2: Estimate capital, labor, and output growth

%Y = 5%

%K = 3%

%L = 1%

Productivity growth will be the residual output growth after correcting for inputs

%A = %Y – (.3)*(%K) – (.7)*(%L)

Growth Accounting


Growth accounting15 l.jpg

Step 1: Estimate capital/labor share of income

K = 30%

L = 70%

Step 2: Estimate capital, labor, and output growth

%Y = 5%

%K = 3%

%L = 1%

Productivity growth will be the residual output growth after correcting for inputs

%A = %Y – (.3)*(%K) – (.7)*(%L)

%A = 5 – (.3)*(3) + (.7)*(1)

= 3.4%

Growth Accounting



The solow model of economic growth l.jpg
The Solow Model of Economic Growth

  • The Solow model is basically a “stripped down” version of our business cycle framework (labor markets, capital markets, money markets)

    • Labor supply (employment) is a constant fraction of the population ( L’ = (1+n)L )

    • Savings is a constant fraction of disposable income: S = a(Y-T)

    • Cash holdings are a constant fraction of income (velocity is constant)


The solow model l.jpg
The Solow Model

  • Labor Markets

    • (w/p) = MPL(A,K,L)

    • L’ = (1+n)L

    • Y = F(A,K,L) = C+I+G


The solow model19 l.jpg
The Solow Model

  • Labor Markets

    • (w/p) = MPL(A,K,L)

    • L’ = (1+n)L

    • Y = F(A,K,L) = C+I+G

  • Capital Markets

    • r = (Pk/P)(MPK(A,K,L) – d)

    • S = I +(G-T)

    • K’ = K(1-d) + I


The solow model20 l.jpg
The Solow Model

  • Labor Markets

    • (w/p) = MPL(A,K,L)

    • L’ = (1+n)L

    • Y = F(A,K,L) = C+I+G

  • Capital Markets

    • r = (Pk/P)(MPK(A,K,L) – d)

    • S = I +(G-T)

    • K’ = K(1-d) + I

  • Money Markets

    • M = PY


The solow model21 l.jpg
The Solow Model

  • Step #1: Convert everything to per capita terms (For Simplicity, Technology Growth is Left Out)

    • x = X/L


Properties of production l.jpg

Recall that we assumed production exhibited constant returns to scale

Therefore, if Y = F(K,L), the 2Y = F(2K,2L)

In fact, this scalability works for any constant

Properties of Production


Properties of production23 l.jpg

Recall that we assumed production exhibited constant returns to scale

Therefore, if Y = F(K,L), the 2Y = F(2K,2L)

In fact, this scalability works for any constant

Y = F(K,L)

(1/L)Y = F((1/L)K, (1/L)L)

Y/L = F(K/L, 1) = F(K/L)

y = F(k)

Properties of Production


Properties of production24 l.jpg

Recall that we assumed production exhibited constant returns to scale

Therefore, if Y = F(K,L), the 2Y = F(2K,2L)

In fact, this scalability works for any constant

Y = F(K,L)

(1/L)Y = F((1/L)K, (1/L)L)

Y/L = F(K/L, 1) = F(K/L)

y = F(k)

MPL is increasing in k

MPK is decreasing in k

Properties of Production


Labor markets l.jpg
Labor Markets to scale

  • w/p = MPL(k) and MPL is increasing in k

  • y = F(k) = c + i + g

  • L’ = (1+n)L


Capital markets l.jpg
Capital Markets to scale

  • r = MPK(k) – d with MPK declining in k

  • s = i + (g-t) = a(y-t) = a(F(k)-t)

  • k’(1+n) = k(1-d) + i


The solow model27 l.jpg
The Solow Model to scale

  • Step #1: Convert everything to per capita terms (For simplicity, Technology Growth is left out)

    • x = X/L

  • Step #2: Find the steady state

    • In the steady state, all variables are constant.


Steady state investment l.jpg
Steady State Investment to scale

  • In the steady state, the capital/labor ratio is constant. (k’=k)

    k’(1+n) = (1-d)k + i


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Steady State Investment: to scale

  • In the steady state, the capital/labor ratio is constant. (k’=k)

    k’(1+n) = (1-d)k + i

    k(1+n) = (1-d)k + i


Steady state investment30 l.jpg
Steady State Investment to scale

  • In the steady state, the capital/labor ratio is constant. (k’=k)

    k’(1+n) = (1-d)k + i

    k(1+n) = (1-d)k + i

    Solving for i gives is steady state investment

    i = (n+d)k



Steady state output savings l.jpg
Steady State Output/Savings to scale

  • Given the steady state capital/labor ratio, steady state output is found using the production function

    y = F(k)

  • Recall that MPK is diminishing in k






Steady state l.jpg
Steady State to scale

  • In this example, steady state k (which is K/L) is 50.

  • Steady state investment (i) = steady state savings(s) = 15

  • Steady state output (y) equals F(50) = 400

  • Steady state government spending (g) = steady state taxes (t) = 100

  • Steady state consumption = y – g – i = 285

  • Steady state factor prices come from firm’s decision rules:

    • W/P = MPL(k) , r = MPK(k) – d

  • The steady state price level (P) = M/Y


Growth vs income l.jpg
Growth vs. Income to scale

  • Suppose that the economy is currently at a capital/labor ratio of 20.



Growth vs income40 l.jpg
Growth vs. Income to scale

  • Suppose that the economy is currently at a capital/labor ratio of 20.

    • Investment = Savings = 7.5. This is higher than the level of investment needed to maintain a constant capital stock (6).

    • With the extra investment, k will grow.

    • As k grows, wages will rise and interest rates will fall.


Growth vs income41 l.jpg
Growth vs. Income to scale

  • Suppose that the economy is currently at a capital/labor ratio of 20.

    • Investment = Savings = 7.5. This is higher than the level of investment needed to maintain a constant capital stock (6).

    • With the extra investment, k will grow.

    • As k grows, wages will rise and interest rates will fall.

  • Suppose the economy is at a capital/labor ratio of 70.



Growth vs income43 l.jpg
Growth vs. Income to scale

  • Suppose that the economy is currently at a capital/labor ratio of 20.

    • Investment = Savings = 7.5. This is higher than the level of investment needed to maintain a constant capital stock (6).

    • With the extra investment, k will grow.

    • As k grows, wages will rise and interest rates will fall.

  • Suppose the economy is at a capital/labor ratio of 70.

    • Investment = Savings = 6.5. This is less than the investment required to maintain a constant capital stock.

    • Without sufficient investment, the economy will shrink.

    • As k falls, interest rates rise and wages fall.


Growth vs income44 l.jpg
Growth vs. Income to scale

  • Poor (developing) countries (low capital/income ratio) are below their eventual steady state. Therefore, these countries should be growing rapidly

  • Wealthy (developed) countries (high capital/labor ratio) are at or above their eventual steady state. Therefore, these countries will experience little or no growth.


Growth vs income45 l.jpg
Growth vs. Income to scale

  • Poor (developing) countries (low capital/income ratio) are below their eventual steady state. Therefore, these countries should be growing rapidly

  • Wealthy (developed) countries (high capital/labor ratio) are at or above their eventual steady state. Therefore, these countries will experience little or no growth.

  • The implication is that we will all end up in the same place eventually. This is known as absolute convergence


Growth vs income46 l.jpg
Growth vs. Income to scale

  • Poor (developing) countries (low capital/income ratio) are below their eventual steady state. Therefore, these countries should be growing rapidly

  • Wealthy (developed) countries (high capital/labor ratio) are at or above their eventual steady state. Therefore, these countries will experience little or no growth.

  • The implication is that we will all end up in the same place eventually. This is known as absolute convergence

  • So, what’s wrong with Haiti?


Conditional convergence l.jpg
Conditional Convergence to scale

  • Our previous analysis is assuming that every country will eventually end up at the same steady state. Suppose that this is not the case.

    For example, suppose that a country experiences a decline in population growth. How is the steady state affected?




Conditional convergence50 l.jpg
Conditional Convergence to scale

  • Our previous analysis is assuming that every country will eventually end up at the same steady state. Suppose that this is not the case.

    For example, suppose that a country experiences a decline in population growth. How is the steady state affected?

  • With a lower population growth, the steady state increases from 50 to 85. With an increase in the steady state, this country finds itself further away from its eventual ending point. Therefore, growth increases.

  • Conditional convergence states that a country’s growth rate is proportional to the distance from that county’s steady state


Another example l.jpg
Another Example to scale

  • Suppose that savings rate in a country declines. How is the steady state effected?




Another example54 l.jpg
Another Example to scale

  • Suppose that savings rate in a country declines. How is the steady state effected?

  • With a lower steady state (the steady state falls from 85 to 75), the country finds itself closer to its finishing point. Therefore, its growth rate falls.



Low income low growth countries l.jpg
Low Income/Low Growth Countries to scale

  • This combination is a symptom of a very low steady state. Therefore, the solution would be

    • Lower Population Growth

    • Higher Domestic Savings (Or Open up country to foreign savings)


Low income low growth countries57 l.jpg
Low Income/Low Growth Countries to scale

  • This combination is a symptom of a very low steady state. Therefore, the solution would be

    • Lower Population Growth

    • Higher Domestic Savings (Or Open up country to foreign savings)

  • Another possibility could be the existence of barriers to capital formation

    • Encourage enforcement of property rights.


Low income low growth countries58 l.jpg
Low Income/Low Growth Countries to scale

  • This combination is a symptom of a very low steady state. Therefore, the solution would be

    • Lower Population Growth

    • Higher Domestic Savings (Or Open up country to foreign savings)

  • Another possibility could be the existence of barriers to capital formation

    • Encourage enforcement of property rights.

  • Foreign Aid?


High income low growth countries l.jpg
High Income/Low Growth Countries to scale

  • These countries are probably nearing their (high) steady state. Therefore, recommendations would be:

    • Consider lowering size/scope of government

    • Promote the development of new technologies