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CHAP07 Growth

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CHAP07 Growth

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Gregory Mankiw

PowerPoint Slides by Ron Cronovich

CHAPTE

R

Economic Growth I:

Capital Accumulation and

Modified for EC 204

Population Growth by Bob Murphy

2010 Worth Publishers, all rights reserved

SEVENTH EDITIO

MACROECONOMICS

the closed economy Solow model

how a countrys standard of living depends

on its saving and population growth rates

optimal saving rate and capital stock

Data on infant mortality rates:

20% in the poorest 1/5 of all countries

0.4% in the richest 1/5

In Pakistan, 85% of people live on less than $2/day.

One-fourth of the poorest countries have had

famines during the past 3 decades.

and minorities.

Economic growth raises living standards and

reduces poverty.

CHAPTER 7

Economic Growth I

selected countries, 2000

Madagascar

India

Nepal

Bangladesh

Botswana

Kenya

China

Peru

Mexico

Thailand

Brazil

Russian

Federation

Chile

S. Korea

Anything that effects the long-run rate of economic

growth even by a tiny amount will have huge

effects on living standards in the long run.

percentage increase in

standard of living after

annual growth

rate of income

per capita

25 years

50 years

100 years

2.0%

64.0%

169.2%

624.5%

2.5%

85.4%

243.7%

1,081.4%

CHAPTER 7

Economic Growth I

If the annual growth rate of U.S. real GDP per

capita had been just one-tenth of one percent

higher during the 1990s, the U.S. would have

generated an additional $496 billion of income

during that decade.

CHAPTER 7

Economic Growth I

can make a positive difference in the lives of

hundreds of millions of people.

These lessons help us

understand why poor

countries are poor

design policies that

can help them grow

learn how our own

growth rate is affected

by shocks and our

governments policies

CHAPTER 7

Economic Growth I

due to Robert Solow,

won Nobel Prize for contributions to

the study of economic growth

a major paradigm:

widely used in policy making

benchmark against which most

recent growth theories are compared

and the standard of living in the long run

CHAPTER 7

Economic Growth I

from Chapter 3s model

1. K is no longer fixed:

depreciation causes it to shrink

2. L is no longer fixed:

3. the consumption function is simpler

CHAPTER 7

Economic Growth I

10

from Chapter 3s model

4. no G or T

we can still do fiscal policy experiments)

5. cosmetic differences

CHAPTER 7

Economic Growth I

11

In aggregate terms: Y = F (K, L)

Define: y = Y/L = output per worker

k = K/L = capital per worker

zY = F (zK, zL ) for any z > 0

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

y = F (k, 1)

y = f(k)

CHAPTER 7

Economic Growth I

12

Output per

worker, y

f(k)

MPK = f(k +1) f(k)

1

Note:

Note: this

this production

production function

function

exhibits

exhibits diminishing

diminishing MPK.

MPK.

Capital per

worker, k

CHAPTER 7

Economic Growth I

13

Y=C+I

(remember, no G )

In per worker terms:

y=c+i

where c = C/L and i = I /L

CHAPTER 7

Economic Growth I

14

s = the saving rate,

the fraction of income that is saved

(s is an exogenous parameter)

Note: s is the only lowercase variable that

is not equal to

its uppercase version divided by L

(per worker)

CHAPTER 7

Economic Growth I

15

saving (per worker)

= y c

= y (1s)y

= sy

Rearrange to get: i = y c = sy

(investment = saving, like in chap. 3!)

i = sy = sf(k)

CHAPTER 7

Economic Growth I

16

investment

Output per

worker, y

f(k)

c1

sf(k)

y1

i1

k1

CHAPTER 7

Economic Growth I

Capital per

worker, k

17

Depreciation

Depreciation

per worker, k

= the fraction of the capital stock

that wears out each period

k

CHAPTER 7

Economic Growth I

Capital per

worker, k

18

Capital accumulation

The basic idea: Investment increases the capital

stock, depreciation reduces it.

Change in capital stock

k

= investment depreciation

=

i

k = s f(k) k

CHAPTER 7

Economic Growth I

19

k = s f(k) k

The Solow models central equation

Determines behavior of capital over time

which, in turn, determines behavior of

all of the other endogenous variables

because they all depend on k. E.g.,

y = f(k)

CHAPTER 7

Economic Growth I

20

k = s f(k) k

If investment is just enough to cover depreciation

[sf(k) = k ],

then capital per worker will remain constant:

k = 0.

This occurs at one value of k, denoted k*,

called the steady state capital stock.

CHAPTER 7

Economic Growth I

21

Investment

and

depreciation

k

sf(k)

k*

CHAPTER 7

Economic Growth I

Capital per

worker, k

22

state

Investment

and

depreciation

k = sf(k)

k

k

sf(k)

investment

depreciation

k1

CHAPTER 7

Economic Growth I

k*

Capital per

worker, k

23

Investment

and

depreciation

k = sf(k)

k

k

sf(k)

k

k1 k2

CHAPTER 7

Economic Growth I

k*

Capital per

worker, k

24

Investment

and

depreciation

k = sf(k)

k

k

sf(k)

investment

depreciation

k2

CHAPTER 7

Economic Growth I

k*

Capital per

worker, k

25

Investment

and

depreciation

k = sf(k)

k

k

sf(k)

k

k2 k3 k*

CHAPTER 7

Economic Growth I

Capital per

worker, k

27

Investment

and

depreciation

k = sf(k)

k

sf(k)

Summary:

Summary:

As

As long

long as

as kk << kk**,,

investment

investment will

will exceed

exceed

depreciation,

depreciation,

and

and kk will

will continue

continue to

to

grow

grow toward

toward kk**..

k3 k*

CHAPTER 7

Economic Growth I

Capital per

worker, k

28

An increase in the saving rate raises investment

causing k to grow toward a new steady state:

Investment

and

depreciation

dk

s2 f(k)

s1 f(k)

k

CHAPTER 7

Economic Growth I

35

Prediction:

And since y = f(k) ,

higher k* higher y* .

with higher rates of saving and investment

will have higher levels of capital and income per

worker in the long run.

CHAPTER 7

Economic Growth I

36

rates and income per person

Income per

person in

2003

(log scale)

(average 1960-2003)

Different values of s lead to different steady states.

How do we know which is the best steady state?

consumption per person: c* = (1s) f(k*).

An increase in s

leads to higher k* and y*, which raises c*

reduces consumptions share of income (1s),

which lowers c*.

CHAPTER 7

Economic Growth I

38

the Golden Rule level of capital,

the steady state value of k

that maximizes consumption.

To find it, first express c* in terms of k*:

c*

CHAPTER 7

y*

i*

= f (k*)

i*

= f (k*)

k*

Economic Growth I

i* = k* because

k = 0.

39

steady state

output and

depreciation

Then, graph

f(k*) and k*,

look for the

point where

the gap between

them is biggest.

CHAPTER 7

Economic Growth I

k*

f(k*)

steady-state

capital per

worker, k*

40

cc** == f(k

f(k**))

k

k**

is

is biggest

biggest where

where

the

the slope

slope of

of the

the

production

production function

function

equals

equals

the

the slope

slope of

of the

the

depreciation

depreciation line:

line:

k*

f(k*)

MPK =

CHAPTER 7

Economic Growth I

steady-state

capital per

worker, k*

41

Golden Rule steady state

The economy does NOT have a tendency to

move toward the Golden Rule steady state.

policymakers adjust s.

with higher consumption.

during the transition to the Golden Rule?

CHAPTER 7

Economic Growth I

42

then

then increasing

increasing cc

requires

requires aa fall

fall in

in s.

s.

**

c

In

In the

the transition

transition to

to

the

the Golden

Golden Rule,

Rule,

consumption

consumption is

is

higher

higher at

at all

all points

points

in

in time.

time.

CHAPTER 7

Economic Growth I

t0

time

43

then

then increasing

increasing cc**

requires

requires an

an

increase

increase in

in s.

s.

Future

Future generations

generations

enjoy

enjoy higher

higher

consumption,

consumption,

but

but the

the current

current

one

one experiences

experiences

an

an initial

initial drop

drop

in

in consumption.

consumption.

CHAPTER 7

y

c

Economic Growth I

t0

time

44

Population growth

Assume the population and labor force grow

at rate n (exogenous):

population is growing at 2% per year (n = 0.02).

so L = 1,020 in year 2.

CHAPTER 7

Economic Growth I

45

Break-even investment

the amount of investment necessary

to keep k constant.

k to replace capital as it wears out

n k to equip new workers with capital

(Otherwise, k would fall as the existing capital stock

is spread more thinly over a larger population of

workers.)

CHAPTER 7

Economic Growth I

46

With population growth,

the equation of motion for k is:

k = s f(k) ( + n) k

actual

investment

CHAPTER 7

Economic Growth I

break-even

investment

47

Investment,

break-even

investment

k = s f(k) (

+n)k

( + n ) k

sf(k)

k*

CHAPTER 7

Economic Growth I

Capital per

worker, k

48

growth

Investment,

break-even

investment

( +n2) k

( +n1) k

An increase in n

causes an increase

in break-even

investment,

leading to a lower

steady-state level

of k.

sf(k)

k2*

CHAPTER 7

Economic Growth I

worker, k

49

Prediction:

Higher n lower k*.

And since y = f(k) ,

lower k* lower y*.

with higher population growth rates will have

lower levels of capital and income per worker in

the long run.

CHAPTER 7

Economic Growth I

50

growth and income per person

Income per

person in

2003

(log scale)

Population growth

(percent per year, average 1960-2003)

growth

To find the Golden Rule capital stock,

express c* in terms of k*:

c* =

y*

= f (k* )

i*

( + n) k*

c* is maximized when

MPK = + n

or equivalently,

MPK = n

CHAPTER 7

Economic Growth I

In the Golden

Rule steady state,

the marginal product

of capital net of

depreciation equals

the population

growth rate.

52

Alternative perspectives on

population growth

The Malthusian Model (1798)

Predicts population growth will outstrip the

Earths ability to produce food, leading to the

impoverishment of humanity.

Since Malthus, world population has increased

sixfold, yet living standards are higher than ever.

Malthus neglected the effects of technological

progress.

CHAPTER 7

Economic Growth I

53

Alternative perspectives on

population growth

The Kremerian Model (1993)

Posits that population growth contributes to

economic growth.

More people = more geniuses, scientists &

engineers, so faster technological progress.

Evidence, from very long historical periods:

As world pop. growth rate increased, so did rate

of growth in living standards

Historically, regions with larger populations have

enjoyed faster growth.

CHAPTER 7

Economic Growth I

54

Chapter Summary

1. The Solow growth model shows that,

depends:

positively on its saving rate

negatively on its population growth rate

2. An increase in the saving rate leads to:

faster growth temporarily

but not faster steady state growth

Chapter Summary

3. If the economy has more capital than the

increase consumption at all points in time,

making all generations better off.

If the economy has less capital than the

Golden Rule level, then increasing saving will

increase consumption for future generations,

but reduce consumption for the present

generation.

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