Transcript Chapter 2

Chapter 3
Growth and Accumulation
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
1
Chapter Organisation
3.1 Growth Accounting
3.2 Empirical Estimates of Growth
3.3 Neoclassical Growth Theory
3.4 Convergence
3.5 Exogenous Technological Change
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
2
3.1 Growth Accounting

Growth accounting explains:
 the contribution of factors of production
 to the growth in total output

The production function is
Y = AF (K, N)

capital
labour
(3.1)
It shows the quantitative relationship
between factor inputs and output
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
3
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  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
4
Production Function

Transforming Y = AF (K, N) to measure
growth rates gives equation (3.2)
Y Y  1     N N     K K   A A
Output
growth
labour
growth
Labour
share
capital
growth
Capital
share
Technical
progress
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
5
Production Function

Transforming Y = AF (K, N) to measure
growth rates gives equation (3.2)
Y Y  1     N N     K K   A A
Output
growth
labour
growth
Labour
share
capital
growth
Capital
share
Technical
progress
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
6
Production Function
Y Y  1     N N     K K   A A

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  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
7
Production Function

Subtracting population growth N/N from
both sides gives
Y Y  N N     K K  N N   A A
y y    k k  A A
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
(3.4)
8
Production Function
y y    k k  A A
(3.4)
The parameter  usually has a value of 0.25
for Australia
 For the period 1950–92 in Australia

 the average annual growth rate of per capita
capital was 4.3% pa
 the average annual growth rate of per capita
output was 2.0% pa
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
9
Production Function

Equation 3.4 shows that
 per capita capital growth of 4.3% pa
contributed 0.25  4.3% = 1.075% pa to per
capita output growth
 the recorded per capita output growth was
2.0% pa.
 The remaining per capita output growth of
2.0 - 1.075 = 0.925% pa was mostly due to
technological progress
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
10
Production Function

The comparable figures for Japan are
 per capita capital growth of 7.1% pa contributed
0.25  7.1% = 1.775% pa to per capita output
growth
 The recorded per capita output growth was
5.7% pa
 technological progress was responsible for
5.7 - 1.775 = 3.925% pa of the per capita
output growth

Which country is performing better?
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
11
Production Function

Compare these per capita growth rates (%)
GDP
growth
Capital Technolgrowth
ogy
growth
Australia
2.0
4.3
1.0
Japan
5.7
7.1
3.9
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
12
Chapter Organisation
3.1 Growth Accounting
3.2 Empirical Estimates of Growth
3.3 Neoclassical Growth Theory
3.4 Convergence
3.5 Exogenous Technological Change
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
13
3.2 Empirical Estimates of
Growth
The simple production function
Y = AF (K, N)
(3.1)
 Ignores important factor inputs which also
affect economic growth
 Other possible factor inputs are

 natural resources
 public infrastructure capital
 human capital
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
14
Empirical Growth Estimates
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
15
Empirical Growth Estimates

History has shown the two most important
factors that increase GDP are
 capital accumulation (physical and human)
 technical progress
Incorporating human capital (H) into the
production function gives
Y = AF (K, H, N)
(3.5)
 Important to distinguish labour endowment
(N) from acquired human capital skills (H)

Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
16
Chapter Organisation
3.1 Growth Accounting
3.2 Empirical Estimates of Growth
3.3 Neoclassical Growth Theory
3.4 Convergence
3.5 Exogenous Technological Change
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
17
3.3 Growth Theory: The
Neoclassical Model

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 last 150 years
 while other nations such as Bangladesh have
experienced virtually zero growth
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
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

 where 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  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
19
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  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
20
Neoclassical Growth Theory

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)
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
21
Neoclassical Growth Theory

These assumptions give
 steady-state equilibrium (y* and k*)
 where per capita savings equals investment
sy* = sf (k*) = (n + d)k*

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  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
22
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  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
23
Neoclassical Growth Theory
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
24
Neoclassical Growth Theory
Hence, 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  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
25
Chapter Organisation
3.1 Growth Accounting
3.2 Empirical Estimates of Growth
3.3 Neoclassical Growth Theory
3.4 Convergence
3.5 Exogenous Technological Change
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
26
3.4 Convergence

Neoclassical growth theory predicts
absolute convergence for economies with
 equal rates of savings and population growth
 access to the same technology

This model predicts conditional
convergence for economies that differ in
 rates of savings,
 human capital development
 or population growth
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
27
Convergence

Conditional convergence means
 steady-state per capita incomes differ
 while per capita incomes growth rates equalise

Empirical evidence 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
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
28
Chapter Organisation
3.1 Growth Accounting
3.2 Empirical Estimates of Growth
3.3 Neoclassical Growth Theory
3.4 Convergence
3.5 Exogenous Technological Change
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
29
3.5 Exogenous
Technological Change

The comparison of Australia and Japan
shows the importance of technology
GDP
growth
Capital Technolgrowth
ogy
growth
Australia
2.0
4.3
1.0
Japan
5.7
7.1
3.9
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
30
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 alternative is labour-augmenting
technology Y = F (K, AN)
We will stay with (TFP)
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
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 capitallabour ratio
 However, the growth rate of per-capita
output remains constant
 It grows at the same constant TFP rate

Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
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 TFP

Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch,
Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson
33