Chapter 3 Introduction to Economic Growth

The standard of living is measured by per capita real GDP.

Why we need economic growth?It is the only way for poor countries to achieve

higher standard of living in the long run. Related questions:

What determines long-term growth rates?Why countries grow at different rates?How to increase the rate of economic growth?

Facts about Economic Growth

Facts about Economic Growth

Facts about Economic Growth The richest in 2000: mostly OECD members. The poorest in 2000: mostly sub-Saharan

countries. The richest in 1960: mostly OECD members, a

few Latin American countries, but no Asian economies.

The poorest in 1960: mostly sub-Saharan countries, and a few Asian countries.

The spread was greater in 2000 than in 1960.

Facts about Economic Growth

Facts about Economic Growth Average growth rate: 1.8% per year. Most fast-growing economies are from East

Asia. Most slow-growing countries are from sub-

Saharan Africa.15 African countries experienced negative growth.

OECD members were rich in 1960, but their growth rates are relatively low.

Facts about Economic Growth

Facts about Economic Growth

Facts about Economic Growth Income inequality is severe. Economic growth reduces poverty from 1970

to 2000.The income distribution shifts to the right.

Economic growth has mixed results on inequality.Inequality rose within several large countries.Inequality is lower between large countries.

Facts about Economic Growth Why OECD members are rich?

Moderate growth rate: around 2% per year;Sustainable growth for a long time.

Productivity slow-down:Growth rate over 1960-1980: 3.1% (temporary);Growth rate over 1980-2000: 1.8% (long-term

rate).

Facts about Economic Growth Questions:

What makes some countries to grow faster than others?

What makes the long-term sustainable growth in OECD members possible?

How can policymakers increase growth?

The Production Function The production function:

Inputs: K and L (later H);Technology: A;

Y=AF(K, L) Diminishing marginal products:

∂Y/∂K is decreasing in K;∂Y/∂L is decreasing in L.

The Production Function Constant return to scale:

Y=AF(K, L)Y/L=AF(K/L, L/L)

defining y=Y/L, k=K/L;

y=AF(k, 1)=Af(k) Implications:

( ) ( ) ( )Y

LAf k L Af k Af kK K L k

2,1 ( ) ( )

( ( ) ( ))

Y K KLAF Af k LAf k

L L L L

A f k kf k

The Production Function The production function

The Production Function The production function in its reduced form

Growth Accounting The relation between the growth rate of Y and

the growth rates of A, K, and L. Euler's homogeneous function theorem:

( , )F F

F K L K LK L

Factor remunerations: r=∂Y/∂K, w=∂Y/∂L Factor income shares:

rK Y K AK F wL Y L AL F

Y K Y Y K Y L Y Y L

1K F L F

F K F L

Growth Accounting Growth accounting formula:

Y A F A F K F L

Y A F A K F L F

A F K K F L L

A K F K L F L

A K L

A K L

orY A K L

Y A K L

The Solow Growth Model Assumptions:

Full employment;No government.

Growth rate without technological progress:

(1 )Y K L

Y K L

Y L K L

Y L K L

y k

y k

The Solow Growth Model The growth rate of capital:

National income: Y-KPrivate saving: s(Y-K)Net investment: I-KSaving-investment identity: s(Y-K)=I-KCapital accumulation: K=I-K=s(Y-K)Growth rate of capital stock:

K Ys s

K K

The Solow Growth Model The growth rate of labor:

Same as the growth rate of population;Assuming constant growth rate: L/L=n

The dynamics:

k K L Y ys s n s s n

k K L K k

( )( )

( )

y kf k k kk

y f k k k

The Solow Growth Model Diminishing average product of capital

The Solow Growth Model Determination of the growth rate of capital per capita

The Solow Growth Model The transitional path of capital per capita

The Solow Growth Model Steady state: k/k becomes a constant.

*

*0

ys s nk

*

*

( )0

f ksA s n

k

* *( )y Af k