Download Atanu Dey - Econ171 Economic Development 2011

Atanu Dey
5th Meeting
Mon 27th June, 2011
2:00 PM – 3:30 PM
3 Le Conte
Rates of growth of real per-capita income are .
. . diverse, even over sustained periods . . . I
do not see how one can look at figures like
those without seeing them as representing
possibilities. . .
The consequences for human welfare involved
in [questions related to development] are
simply staggering: Once one starts thinking
about them, it is hard to think about anything
else.
-- Robert Lucas
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[A] unity of interests would exist if there were
rigid links between economic production (as
measured by income per head) and human
development (reflected by human indicators
such as life expectancy or literacy, or
achievements such as self-respect, not easily
measured). But these two sets of indicators
are not very closely related.
-- Paul Streeten (1994)
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Short-term economic gains through
technological progress lost in population growth
Majority in 1800 poorer than their remote
caveman ancestors
Life expectancy and stature equal or lower than
hunter-gatherers
The economic future is one of universal
prosperity
Income growth is central to development
Economic life until the 1800s described by the
Malthusian Trap
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Rev Thomas Malthus’ essay of 1798 on The
Principles of Population
Technological advance ~ 0.05 percent per
year (about a 30th of present rates)
Population growth impoverishes economies
◦ reduced population growth rates improves material
living standards
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They lived above the bare subsistence levels
◦ It is possible to fall below the Malthusian
subsistence levels
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Population levels low in pre-industrial England
relative to Japan due to hygiene levels
Mankind subject to Darwinian natural selection
even after the Neolithic Revolution of 8000 BCE
led to settled agriculture
Economic success led to reproductive success –
which meant downward mobility
Industrial Revolution due to productivity
advances arising out of technological progress
Efficiency advances translated into material
prosperity instead of population increase
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Industrial Revolution
Demographic Transition
◦ Decline in fertility, starting at the top and gradually
working downwards
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Three theories to explain the two events
◦ Changes exogenous to the system – political
institutions such as democracy
◦ External shocks that changed the equilibrium
◦ Gradual evolution of the system – endogenous
growth
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Harrod –Domar Growth Model
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Solow Growth Model
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Endogenous Growth Model
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Economists use models to study economic issues
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A model makes simplifying assumptions about the
world
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It thus allows us to see the relationship among the
variables which would not be evident from
examining the complex real world
Example: To study international trade, a model
with 2 goods, and 2 countries gives useful insights
on the nature of trade
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Circular flow of production, consumption,
saving, and investment
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•Firms and households
•Firms produce stuff
•Firms pay wages,
profits and rents to
households
•Households consume
stuff
•Consumption
expenditure is income
for firms
•Households save
•Savings are investments
for firms
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Developed independently by Sir Roy Harrod in
1939 and Evsey Domar in 1946
Explains growth in terms of the level of
saving and productivity of capital
Production = Consumption goods + Capital
goods
Investment  Capital formation
Saving means delaying present consumption
Growth depends on investing savings in
increasing capital stock
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Y represents income
◦ same as output or production
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K represents capital stock
◦ δ depreciation rate of the capital stock
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S is savings
s is the savings rate, and
I is investment
C is consumption
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Output (or income) is consumption plus
savings at time t
◦ Y(t) = C(t) + S(t)
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The product of the savings rate and output
equals saving, which equals investment
◦ sY = S = I
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The change in the capital stock equals
investment less the depreciation of the
capital stock
◦ K(t+1) = (1 – δ)K(t) + I(t)
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The Harrod-Domar model makes the
following a priori assumptions:
There is a direct relationship between the
capital stock K and the output Y
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It is called the capital-output ratio
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It is usually between 3 and 1
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Savings rate is s
◦ s = S(t)/Y(t)
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Capital-output ratio is θ
◦ Amount of capital required to produce one unit of
output
◦ θ = K(t)/Y(t)
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Rate of growth g
◦ g = [Y(t+1) – Y(t)]/Y(t)
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s/θ = g + δ
Equation
– the Harrod-Domar
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g = s/θ - δ
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It links growth rate g to two other rates
◦ The savings rate s and the capital-output ratio θ
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What’s the effect of population growth?
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Population P grows at rate n
◦ P(t+1) = P(t)(1 +n)
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Per capita income is y(t)
◦ y(t) = Y(t)/P(t)
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Per capita income growth rate is g*
◦ y(t+1) = y(t)(1 + g*)
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New equation
◦ s/θ = (1 + g*)(1 + n) – (1 – δ)
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Combines savings ability, capital productivity,
depreciation, and population growth
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◦ s/θ = (1 + g*)(1 + n) – (1 – δ)
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(1 + g*)(1 + n) = 1 + g* + n + g*n
But g* and n small numbers, and so g*n is
negligible
So s/θ ≈ g* + n + δ
Interpretation:
◦ Per capita growth rate is reduced by population
growth rate and by capital depreciation rate
◦ Per capita growth rate is increased by savings rate
and by more efficient use of capital
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H-D models saving rate, capital-output ratio, and
population growth rate as constants, and not
affected by the growth of the economy
 s, n and θ are considered exogenous
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What if saving rate is a function of per capita
income?
◦ Poor people cannot save at the same rate as those who
are rich
◦ Distribution of income – and not just per capita income –
affects the saving rate
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Therefore saving rate may rise with rising
incomes
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Population growth rate declines as incomes
go up
Why?
n is endogenous
The capital-output ratio also changes due to
the law of diminishing returns to individual
factors of production
When capital level is low, the marginal
productivity of capital is high
So θ is endogenous as well
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Implications of the H-D Growth model
◦ http://bit.ly/lE7ZC2
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“The Harrod-Domar Growth Model”
◦ http://www.sjsu.edu/faculty/watkins/growthmodels.htm
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