Download Chapter 3

Chapter 3
Growth and Accumulation
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley.
3-1
Objectives
•
Identify the sources of long-run
economic growth
•
Examine the neoclassical model
of economic growth
•
Analyse the role of savings, investment
and technology in the growth process
•
Compare the pattern of growth between
countries
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley.
3-2
Chapter Organisation
3.1
Growth Accounting
3.2
Empirical Estimates of Growth
3.3
Neoclassical Growth Theory
3.4
Exogenous Technological Change
3.5
Convergence
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-3
3.1 Growth Accounting
• Output grow through increases in inputs
and increases in productivity.
• Growth accounting explains:
– The contribution of factors of production
– To the growth in total output.
• The production function is:
Y = AF(K, N)
(3.1)
• It shows the quantitative relationship between
factor inputs and output.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-4
Production Function
• Y = AF(K, N)
(3.1)
• The production function shows that output is
positively correlated with:
– The marginal product of labour (MPN) defined as Y/ N
– The marginal product of capital (MPK) defined as Y/ K
– Technology given by the parameter A.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-5
Production Function
• Transforming Y = AF(K, N) to measure growth
rates gives Equation (3.2):
Y/Y = [(1 – θ) ☓ N/N] + (θ ☓ K/K) + A/A
labour
growth
Output
growth
Labour
share
capital
growth
Capital
share
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
Technical
progress
3-6
Production Function
• Transforming Y = AF(K, N) to measure growth
rates gives Equation (3.2):
Y/Y = [(1 – θ) x N/N] + (θ x K/K) + A/A
Output
growth
labour
growth
Labour
share
capital
growth
Capital
share
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
Technical
progress
3-7
Production Function
• Y/Y = [(1 – θ) x N/N] + (θ x K/K) + A/A (3.2)
• Equation (3.2) summarises the contribution of each
input to the growth of output.
• The contribution of labour and capital to output
equals:
– Their individual growth rates
– Multiplied by the share of that input towards output.
• The third term is total factor productivity (TFP),
which measures the rate of technical progress.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-8
Production Function
• The rate of growth per capita is a better indicator
of standards of living and allows more accurate
comparisons between countries.
• The growth accounting equation can be translated
into per capita terms by subtracting population
growth N/N from both sides.
y/y = Y/Y = θ x k/k + A/A
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
(3.4)
3-9
Production Function
• y/y = Y/Y = θ x k/k + A/A
(3.4)
• The parameter  usually has a value of 0.25
for Australia.
• Equation (3.4) suggests that a 1% increase in
the amount of capital available to each worker
will increase per capita output by 0.25 of 1%.
• The quantitative link is less than one because
of diminishing returns to capital per capita.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-10
Production Function
• Diminishing marginal returns occur when the
incremental increases in inputs produces
progressively less increases in output.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-11
Chapter Organisation
3.1
Growth Accounting
3.2
Empirical Estimates of Growth
3.3
Neoclassical Growth Theory
3.4
Exogenous Technological Change
3.5
Convergence
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-12
3.2 Empirical Estimates of Growth
• Empirical studies of growth have suggested
that technical progress is also an important
element in the growth process.
• Robert Solow estimated a growth equation
for the US economy between 1909 and 1949.
• This equation indicated that the average
annual growth in GDP was 2.9%.
• Of this, 0.32 was attributable to capital
accumulation, 1.09% to increases in labour
and 1.49% to technical progress.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-13
Empirical Estimates of Growth
• The model of the production function assumes
that capital and labour are the key determinants
of growth.
• This ignores important factor inputs that
also affect economic growth.
• Other possible factor inputs are:
– Human capital
– Natural resources
– Public infrastructure capital.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-14
Empirical Growth Estimates
• Human capital is the individual’s investment in
education and training which leads to increases
in productivity.
• Incorporating human capital (H) into the
production function gives:
Y = AF(K, H, N)
(3.5)
• It is important to distinguish labour endowment (N)
from acquired human capital skills (H).
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-15
Empirical Growth Estimates
• The natural resources of a country may give
it an advantage which contributes to economic
growth.
• Likewise, public sector investment in capital
infrastructure can result in increased private
sector productivity.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-16
Chapter Organisation
3.1
Growth Accounting
3.2
Empirical Estimates of Growth
3.3
Neoclassical Growth Theory
3.4
Exogenous Technological Change
3.5
Convergence
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-17
3.3 Growth Theory: The Neoclassical
Model
• Neoclassical growth theory focuses on capital
accumulation and its link to savings decisions.
• It highlights the role of technological advances
in determining long-run growth.
• Growth theory attempts to explain:
– How economic decisions affect the accumulation
of the factors of production
– Why some nations such as the US and Japan
have grown rapidly over the past 150 years
– While other nations such as Bangladesh have
experienced virtually zero growth.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-18
Neoclassical Growth Theory
• Initially, neoclassical growth theory assumes
there is no technical progress.
• This implies that the economy will reach a
steady-state equilibrium.
• The steady-state equilibrium occurs at the
point where pre capita variables do not change.
At this point:
– Per capita GDP and per capita capital remain constant.
– Per capita capital cannot grow endlessly because of
diminishing marginal product of capital.
– The economy, therefore, reaches a steady-state
equilibrium.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-19
Neoclassical Growth Theory
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-20
Neoclassical Growth Theory
• The production function in Figure 3.3 shows
the relationship between per capita output
and the capital/labour ratio.
• As capital rises output rises, the marginal
product of capital declines as more capital
is added reflecting the diminishing marginal
product of capital.
• The diminishing marginal product of capital
provides the key to why economies reach a
steady state.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-21
Neoclassical Growth Theory
• In a steady state the level of investment required
to maintain per capita capital depends on:
– Population growth (n = N/N)
– The depreciation rate (d).
• The economy needs investment to maintain
the level of per capita capital:
– nk to provide capital for new workers
– dk to replace existing capital
– total investment requirement is (n + d)k
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-22
Neoclassical Growth Theory
• The level of savings is the other link in the
growth process.
• Assume:
–
–
–
–
Constant population growth (n) and depreciation (d)
A closed economy
There is no government sector
Savings are a constant fraction (s) of income (s is APS).
• Total per capita savings are therefore: sy = sf(k)
• The net change in capital per capita is:
k = sy − (n+d)k
(3.7)
At the steady state the k = 0
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-23
Neoclassical Growth Theory
• These assumptions give:
– Steady-state equilibrium (y* and k*)
– Where per capita savings equals investment.
• sy* = sf(k*) = (n + d)k*
(3.8)
• This relationship is represented in Figure 3.4.
– The saving relationship sf(k*) is the (concave to the
k axis) production function.
– The investment relationship (n + d)k* is the straight ray
from the origin.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-24
Neoclassical Growth Theory
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-25
Neoclassical Growth Theory
• Consider Figure 3.4.
• When saving exceeds investment required:
– sf(k0) > (n + d)k0
– per capita capital increases from k0 to k*.
• Beyond point C:
– Diminishing MPK ensures savings are less than the
required investment.
– sf(k0) < (n + d)k0
– per capita capital decreases to k*.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-26
Neoclassical Growth Theory
• The economy reaches a steady state at point C.
• This implies that steady-state growth rate is not
affected by the level of savings.
• In the long run, an increase in the rate of savings:
– Raises the long-run level of capital and output per capita
– But not the growth rate of output.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-27
Chapter Organisation
3.1
Growth Accounting
3.2
Empirical Estimates of Growth
3.3
Neoclassical Growth Theory
3.4
Exogenous Technological Change
3.5
Convergence
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-28
3.4 Technological Change
• The preceding model adopted a very simplified
view of economic growth over time in order to
explain the relationships between per capita
savings and capital per capita.
• It ignored the role of technology in promoting
economic growth.
• Technology was assumed to be determined
exogenously and remain constant for any
given production function.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-29
Technological Change
• We therefore allow technology to exogenously
increase in the model.
• That is, A/A > 0
• The function Y = AF(K, N) shows the technology
effect as total factor productivity (TFP).
• An exogenous increase in technology causes
the production function and savings function
to shift upwards as in Figure 3.7.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-30
Technological Change
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-31
Technological Change
• The effect of exogenous increases in TFP on
the neoclassical model is similar to an increase
in savings.
• The new steady-state point is at an increasing
per capita output and capital−labour ratio.
• However, the growth rate of per-capita output
remains constant.
• It grows at the same constant TFP rate:
– Steady-state per capita incomes differ.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-32
Technological Change
• The neoclassical growth model is an important
reference.
• However, the model’s assumptions and validity
have been questioned.
• Endogenous growth theory has been developed
to allow for more complicated and realistic
endogenous increases in Total Factor Productivity.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-33
Chapter Organisation
• 3.1 Growth Accounting
• 3.2 Empirical Estimates of Growth
• 3.3 Neoclassical Growth Theory
• 3.4 Exogenous Technological Change
• 3.5 Convergence
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-34
3.5 Convergence
• Neoclassical growth theory predicts that
similar economies with equal rates of savings
and population growth and the same access
to technology will reach the same steadystate income.
• The model predicts absolute convergence
for economies with:
– Equal rates of savings and population growth.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-35
Convergence
• This model predicts conditional convergence for
economies that differ in:
– Rates of savings
– Human capital development, or
– Population growth.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-36
Convergence
• Empirical evidence is not conclusive.
• It suggests that some nations have shown:
– Divergence with poor countries growing slower
than rich nations
– Absolute convergence for some nations with
common characteristics
– Conditional convergence characteristics where
steady state per capita incomes differ and growth
rates in per capita income eventually equalise.
Copyright  2006 McGraw-Hill Australia Pty Ltd
PPTs t/a Macroeconomics 2e by Dornbusch, Bodman, Crosby, Fischer, Startz
Slides prepared by Dr Monica Keneley
3-37