Transcript Capital - Andrews University

MACROECONOMICS
AND THE GLOBAL BUSINESS ENVIRONMENT
Capital Accumulation, Technological
Progress, and Economic Growth
1
PowerPoint by Beth Ingram
University of Iowa
Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.
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Key Concepts
 Definition of Capital and Investment
 Decreasing Marginal Return
 Convergence in Rates of Growth
 The Steady State
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Real GDP
(billions of 1996 $)
Decreasing marginal product
An increase in the
quantity of labor
increases Real But growth
GDP
rate
decreases
as labor
increases
15
12
6
500 1000
1500
Labor Hours
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Real GDP
(billions of 1996 $)
Decreasing marginal product
An increase in the
quantity of capital
increases Real
But growth
GDP
rate
decreases
as capital
increases
15
12
6
500 1000
1500
Quantity of Capital
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Diminishing Marginal Return
 Growth will be fast when level of capital is low
 Growth slows down as capital accumulates
 Eventually, firms won’t add new capital – firms
only replace depreciated capital
 Economy reaches a
Steady State
Growth Convergence
 The return from capital for developing
countries should be higher (everything else
held constant) than wealthy countries
 “Catch Up” (graph)
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Optimal Investment
 Value of new capital is
(Marginal Product) x (Price of Output)
 Suppose 6 units x $2 = $12
 Cost of new capital
 Denoted by r+d


r = interest rate
 Assume resell capital and payoff principal


d = wearing out of capital or depreciation
Taxes may also be important
 Invest in new capital if

Equilibrium: MP x Price of output = r


If MP x Price of output > r…then keep investing in capital until
equalized
If MP x Price of output < r…put investment into financial
market until equalized
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In equilibrium…
Interest Rate
Savings
6%
5%
Investment
5%
10% 12%
Percentage of Income
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In equilibrium…
Interest Rate
Savings
5%
4%
Investment
10%
14%
Percentage of Income
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Suppose increase in TFP
r
Savings
6%
5%
Investment
10% 12%
Percentage of Income
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Suppose declining savings
Interest Rate
Savings
5.5%
5%
Investment
8%
10%
Percentage of Income
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Capital (K)
 Capital formation comes from Investment
 Capital is the total value of the machines and buildings used to
produce output
 Capital depreciates (wears out)
 Assume constant rate of depreciation, d
 Assume depreciation is fraction of capital stock, d*K
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Steady State
 The point where a country can no longer economically grow
by adding more capital


A resting point for capital stock
 Capital can temporarily deviate away, but always comes back
A equilibrium point for the model
 Holding labor and productivity fixed
 Changes in the capital stock come from
 (1) new capital and (2) replacing old depreciated capital
 Gross investment = (1) + (2)
 Net Investment = (1)
 Kt = Kt-1 + It + Dt
(Where Dt = d*Kt-1 and It = b*Yt; 0<d,b<1)
 Stead state: Kt = Kt-1 which implies It = Dt
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Steady State
Real GDP
Output
C+G+X-M
Investment
Investment (20% of GDP)
Capital Stock
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Steady State
Real GDP
Investment = Depreciation
Output
Depreciation
= d x Capital Stock
Investment
Capital Stock
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Depreciation exceeds investment;
capital stock must increase
Output
Real GDP
Depreciation
Investment
KLow
Kss
KHigh
Capital Stock
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Investment exceeds depreciation;
capital stock must decline
Output
Real GDP
Depreciation
Investment
KLow
Kss
KHigh
Capital Stock
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Implications
 Since capital is limited, growth must ultimately come
from productivity
 If all countries eventually have same access to
technology and other factors driving productivity then
all countries should grow at the same rate
 Consequently, how much one country is investing will
not affecting the growth rate

i.e. in the long run, a country’s growth rate is
independent of its investment
 Investment will, however, affect level of output
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Increase in Investment Rate
Output
Real GDP
Depreciation
Investment (30% of GDP)
Investment (20% of GDP)
K20%
K30%
Capital Stock
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The Asian Miracle
 Why did Asian economies grow so fast after
1950?
 Can this experience be repeated elsewhere?
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Growth Accounting
Asian Tigers, 1966 - 1990
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Growth accounting in emerging markets, 1960–1994.
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Growth Accounting
1960-1990
Real GDP Growth
Population Growth
Capital Growth
Brazil
3.60%
2.40%
3.00%
Mexico
4.90%
2.70%
3.20%
Singapore
8.40%
6.40%
11.30%
Contribution to Real GDP Growth
TFP
Population
Capital
Sum to Real GDP Growth
Brazil
Mexico
Singapore
1.02%
1.68%
0.90%
3.60%
2.05%
1.89%
0.96%
4.90%
0.53%
4.48%
3.39%
8.40%
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Does source of growth matter?
 Higher growth means higher standard of
living
 Growth through capital accumulation


Eventually dissipates
Comes at a cost (low consumption in previous
generations)
 Modern economies started industrializing
around 150 years ago…why haven’t they
reached their steady state?
 Transition to TFP-induced growth?
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Effect of an increase in TFP
Real GDP
Production Function, New
Production Function, Old
Depreciation
Investment, New
Investment, Old
K0
K1
Capital
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Production Function Shift
 Summarizing

Increase in Output due to function shift



Increase in Labor
Increase in TFP
Increase in Output due to increase in capital


Economy moves to new steady state
As capital increases, output increases
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TFP
 Institutions
 Property Rights
 Regulatory Institutions
 Macroeconomic Stabilization
 Social Insurance
 Conflict Management
 Political Rights
 Trust/Social Capital
 Culture of Risk Taking and Entrepreneurship
 Technology Gains
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TFP Institutions: Caribbean Example
 2007 World Bank report: Crime, Violence, and
Development: Trends, Costs, and Policy Options in
the Caribbean
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TFP: Institutions Gone Awry ---Rent
Seeking
 Activity in which value-added produced by
one person is taken by another
 Examples

U.S. Farm subsidies
 Concerns



Absorbs resources (labor and capital)
Rent seeking crowds out production
Weakens social capital/breeds corruption
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TFP: Technological Progress
 Another important driver in TFP

not necessarily independent of institutions
 Growth can be sustained through
technological progress

Continued gains to productivity
 Role of Research and Development in
promoting technological progress
4-34
TFP: Technological Progress
R&D per Capita, 1997
Rich countries spend more on R&D
800
600
400
200
0
0
5000
10000 15000
20000 25000 30000 35000
GDP per Capita, 1997
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Aside: Human Capital
 Capital can be broken down into physical and
human capital
 Increase human capital means more output,
even at current levels of physical capital and
labor

means higher steady state level of output and
capital
 May explain some cross-country growth
differentials
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Aside: Human Capital
Percentage of students completing the final year of primary school
Source: World Bank Millennium Development Goals
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Summary
 Marginal Product of Capital
 Implications of decreasing MPK
 Role in determining Steady State
 Steady State Investment
 Investment = Depreciation
 Growth can no longer be achieved through
investment
 TFP
 Institutions
 Technological progress