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Economic Growth

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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Economic Growth

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  1. Economic Growth

  2. The World Economy • Total GDP: $31.5T • GDP per Capita: $5,080 • Population Growth: 1.2% • GDP Growth: 1.7%

  3. The World Economy by Region

  4. 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

  5. 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

  6. Income vs. Growth

  7. 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

  8. 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

  9. 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?)

  10. Sources of Economic Growth • Recall, that we assumed three basic inputs to production • Capital (K) • Labor (L) • Technology (A)

  11. Step 1: Estimate capital/labor share of income K = 30% L = 70% Growth Accounting

  12. 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

  13. 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

  14. 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

  15. 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

  16. Sources of US Growth

  17. 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)

  18. The Solow Model • Labor Markets • (w/p) = MPL(A,K,L) • L’ = (1+n)L • Y = F(A,K,L) = C+I+G

  19. 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

  20. 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

  21. The Solow Model • Step #1: Convert everything to per capita terms (For Simplicity, Technology Growth is Left Out) • x = X/L

  22. 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

  23. 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

  24. 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

  25. Labor Markets • w/p = MPL(k) and MPL is increasing in k • y = F(k) = c + i + g • L’ = (1+n)L

  26. Capital Markets • 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

  27. The Solow Model • 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.

  28. Steady State Investment • In the steady state, the capital/labor ratio is constant. (k’=k) k’(1+n) = (1-d)k + i

  29. Steady State Investment: • 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

  30. Steady State Investment • 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

  31. Steady State Investment n =.20, d = .10

  32. Steady State Output/Savings • 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

  33. Steady State Output

  34. Steady State Net Income (t=100)

  35. Steady State Savings (a=.05)

  36. In Equilibrium, (g-t)=0. Therefore, s=i

  37. Steady State • 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

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

  39. In Equilibrium, (g-t)=0. Therefore, s=i

  40. Growth vs. Income • 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.

  41. Growth vs. Income • 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.

  42. In Equilibrium, (g-t)=0. Therefore, s=i

  43. Growth vs. Income • 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.

  44. Growth vs. Income • 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.

  45. Growth vs. Income • 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

  46. Growth vs. Income • 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?

  47. Conditional Convergence • 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?

  48. A Decline in Population Growth

  49. A Decline in Population Growth

  50. Conditional Convergence • 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

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