Group 4 Economic Theory

8/2/2019 Group 4 Economic Theory

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Group 4

Theories of Economic Growth

Instructor: Msc.NguynTrngc

1. NguynTh Mai Anh

2. uVnHi3. Hong ThM Lin

4. TrnHng Nhung

5. TrnTh H Thng

6. NguynTh Thy Vn

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Introduction

Theories of economic growth are most basic expression of

economic growth based on economic factors and their

relationship.

Some important models of economic growth:

1. Harrod-Domar Growth Model

2. Solow Model

3. Rostow's Model

4. The Lewis Dual Sector Model of Development5. Two-sector models

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The Harrod-DomarGrowth Model

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Theory of Model

Used in developmenteconomics to explain an

economy's growth rate interms of the level ofsaving and productivity ofcapital.

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The starting point of this model

J.Keynes opinion on equilibrium below potential level andthe role of spending(aggregate demand)

Investment causes income effect (Harrod same point withJ.Keynes)

Investment by saving (S = I)

Investment to increase capacity of economy (I = K)

Fixed technology

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Contents of Model

The role of resources factors in the growth

The factor effect directly to the growth Y = f(K,L)

Factors play a decisive role

+ S is the source of investment (I)+ I create K for the following period+ K create directly Y of this period

Saving and investment create capital stock whichplay a decisive role in economic growth.

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Content of Model

Role of the capital in economic growth

The relationship between K and Y +IncrementalCapital Output Ratio (ICOR)

=Kt /Yt = It-1/Yt ICOR measures the productivity of additional capital

which depends on:

+ Level of scarce resource

+ Efficiency of management and using capital

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Harrod-Domar growth model and

the rationale

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The fixed-coefficient production function

Q= min F(L,K): theproduction Isoquant is L

shaped

It shows constant returns

to scale (CRS) i.e.doubling inputs will

double output

The most efficient

production point is at theelbow

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Harrod-Domar Prod. Function

Y= (1/v)x K or Y=K/v (1) Where v= constant or v=K/Y (2)

+ v= capital output ratio or measure of the productivity ofcapital or investment

(1) can be convert to relate changes in output to changes in thecapital stock:Y=K/v (3)

The growth rate of output g=Y/Y(the increment in outputdivided by the total amount of output)

g =

Y/Y=

K/Y*v (4) because K=sY-d*KFinally the Basic Harrod Model:g= (s/v)-d (5)

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The Harrod-Domar model of E.G

Summary

The steady-state rateof growth is

determined by:

the saving rate

the fixed incrementalcapital-output ratio

(ICOR), and

the rate of

depreciation of fixedcapital

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Is its simplicity. The data requirements are small, the equation is easy to use

and estimate.

Can be accurate from one year to next year.

Can do reasonable job of estimating expected growth rates inmost countries over very short periods of time (a few years).

Focuses on the key role of saving.

-> It makes clear that saving is crucial for income to grow over

time.

Advantages

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Disadvantages

It is difficult to stimulate the desired level of domestic savings

Meeting a savings gap by borrowing form overseas causes debtrepayment problems later.

Diminishing marginal returns to capital equipment exist so each

successive unit of investment is less productive and the capital tooutput ratio rises.

The amount of investment is just one factor affectingdevelopment e.g. supply side approach (free up markets); humanresource development (education and training)

Economic growth is a necessary but not sufficient condition fordevelopment

Many developing countries lack a sound financial system

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Solow Model( Neoclassical Growth Model)

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Theory of Solow Model

Is the neoclassical growth

model

Is a class of economic

models of long-run economic

growth.

Explain by looking

at productivity, capital

accumulation, populationgrowth and technological

progress.

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Characteristics

An improvement over Harrod-

Domar Model

It drops fixed coefficient or no

substitution

Allows for substitution between

factors

Y= f(K,L) Labor and Capital are

substitutable The production function is u-

shaped showing substitution as

in figure 4.2

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Solow growth model diagram

The model starts with aneoclassical productionfunction Y/L = F(K/L) or y= f(k).

Where:n = population growth rate

d = depreciationk = capital per worker

y = output/income perworkerL = labor forces = saving rate

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http://upload.wikimedia.org/wikipedia/commons/1/11/Solow_growth_model1.png


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The Basic Solow Growth Model

Point A is where new savings Sy

= amount of new capital needed

for growth in the labor force and

depreciation (n+d).

Point A is steady state level ofcapital per worker where stable

equilibrium occurs

At steady state total output

continues to grow at the rate of

population (n) or labor force, but

GDP per capital (y) is constant.

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The Effect of Changes in Saving Rate

and Population Growth

An increase in the Savingsrate in the Solow Modelfrom s to s results in anshift in capital deepeningcurve

-> So capital per workerincreases from k0 to k3 or Ato B

The population growth ratehas now increased

from n to n, thisintroduces a new capitalwidening line (n+ d)

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The effect of Population Growth in the

Solow Model

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The Effect of Technical Change on

Solow Model

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Strengths of Solow Model

An improvement over Harrod-Domar Fixed coefficient model

Allows for substitution between

inputs and outputs Provides good insights about the

relationship between role oftechnology and innovation ongrowth

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Extension to the HarrodDomar Model

Adding labor as a factor of production

Requiring diminishing returns to labor and capital

separately and constant returns to scale for bothfactors combined

Introducing a time-varying technology variabledistinct from capital and labor.

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http://en.wikipedia.org/wiki/Factor_of_productionhttp://en.wikipedia.org/wiki/Diminishing_returnshttp://en.wikipedia.org/wiki/Constant_returns_to_scalehttp://en.wikipedia.org/wiki/Constant_returns_to_scalehttp://en.wikipedia.org/wiki/Diminishing_returnshttp://en.wikipedia.org/wiki/Factor_of_production


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Weaknesses of Solow Model

Lack of direct insight on thefundamental factor influencingthe steady state.

One sector approach, factorsthat drive steady state, and

assumes saving rate, populationgrowth , and technical changeas given

Not explain how theseparameters change over time.

Not shed light on the role of theallocation of capital and laboramong various sector.

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New Approaches to Growth

The Solow model assumes fixed or exogenous saving rate,growth rate of savings and labor force.

Recent works provides models where these variables aredetermined within or endogenously in the model.

These new models allow for increasing returns to scale andpositive and negative externalities

They are called endogenous models but their estimationsuffers from lack of good data.

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Rostow's Model- the Stages ofEconomic Growth

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Theories

In 1960, Rostow, the American EconomicHistoriansuggested: countries passed through 5stages of economic growth.

Stage1: Traditional societyStage2: Transitional stage ( the preconditions for

takeoff)

Stage3: Take off

Stage4: Drive to maturity

Stage5: High mass consumption

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Rostows Model

Traditionalsociety

Transitional

stage

Take offDrive tomaturity

High massconsumption

Stage 1

Stage 2

Stage 3

Stage 4

Stage 5

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Stage 1: Traditional society

- Characterized by subsistence

agriculture or hunting &

gathering;

- Output not traded or

recorded.

- Limited technology

- Existence of barter

- High levels of agriculture

and labour intensive

agriculture

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Stage 2: Transitional stage

- Increase in

capital use in agriculture

-Some growth in savings and

investment- Emergence of a transport

infrastructure to support

trade

-External trade also occurs:

primary products.

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Stage 3: Take off

-Industrialisationincreases-Some regionalgrowth-The level ofinvestmentreaches over 10%of GNP.

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Stage 3: Take off

-Number employed inagriculture declines

-The "secondary" (goods-producing) sector expands- Further growth in savingsand investment

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http://en.wikipedia.org/wiki/File:Table_for_take-off.jpg


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Stage 4: Drive to maturity

-The economy is diversifyinginto new areas

-Wide range of goods and

services ; less reliance onimports.

- Manufacturing shifts from

investment-driven (capital

goods) towards consumer

durables & domestic

consumption.

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Stage 4: Drive to maturity

-Increase in levels of

technology utilised

-Transportation infrastructuredevelops rapidly

- Large-scale investment in

social infrastructure (schools,

universities, hospitals, etc.)

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Stage 5: High mass consumption

- High output levels

- Mass consumption of

consumer durables

- High proportion of

employment in service

sector

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Advantages of Rostows Model

Is historical in the sense that the end result.

Is known at the outset

Is derived from the historical geography of a developed,

bureaucratic society. Its sense is to determine development level of each country in

each period.

It suggests that each country needs to promote and complete

the needs for the development in each period

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Disadvantages of Rostows Model

Just based on American and European history -> integral to the economic

development process of all industrialized societies.

Not apply to the Asian and the African countries

The stages are not identifiable properly as the conditions of the take-off

and pre take-off stage are every similar and also overlap. Growth is a continuous process, not interrupted, so it is not divided into

clear and exact stages.

Growth and development of some countries dont need to separate above 5

stages The beginning of each country is different while this theory doesnt base

on it

Just studies the growth

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Application for Vietnam

Vietnam is in the take-off stage in the Rostowsmodel

The 1986 Sixth Party Congress approved broadeconomic reforms introduced market reforms,opened up the country for foreign investment, and

dramatically improved Vietnam's business climate(GDP) increases 8% from 1990 to 1997 and 6.5%from 1998-2003

GDP grew more than 8% annually from 2004 to2007

GDP is 6.8% in 2010, and reached 5.8% over thefirst 9 months of 201

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Application for Vietnam

In the first 9 months of 2011, disbursed FDI capital totaled$9.1 billion, up 1% compared to the same period in 2010

From 1990 to 2011, agricultural production nearly doubled

In the first 9 months of 2011, Vietnams exports ($70 billion)were up by 23% compared to the same period in 2010 Per capita income rose from $220 in 1994 to $1,168 in 2010.

Increased to 18.2% in the first 9 months of 2011, up from8.6% in the same period of 2010

Industry and construction contributed 41% of GDP in 2010

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Lewis Dual Sector Model

Sir Arthur Lewis, an economist

from Saint Lucia, is credited for

the development of the Dual

Sector Model.

His contributions to

developmental economics earned

him a Nobel Prize in economics.

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Theory of Model

Is a structural- change theory.

Explains the mechanism of changing structure of

underdeveloped economics Move from subsistence agriculture to more modern

and more urbanized.

Became the general theory of the development

process for surplus labor nation during 1960s and

early 1970s.

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Dual Sector Model

Traditional sector

Is overpopulated subsistencesector.

Marginal productivity oflabor is zero.

Mainly agriculture

Is characterized by very

stagnant Labor productivity is very

low and surplus labor

Modern sector

Is urban industrial sector.

Productivity is high

Be able to accumulate.. Labor is gradually transferred

into this sector from traditional

sector

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The Lewis Model

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The advantages of Model

Attracted attention of

underdeveloped countries.

Brings out some basic

relationships in dualistic

development.

Provide a good general theory

on labour transitioning indeveloping economies.

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Disadvantages of Lewis Model

Capital accumulation

Surplus Labor

Competitive labor market in

modern sector

The modern sector might

continue to use more and more

of capital instead of labor.

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Viet Nam economic

Is not a dualistic economy

But its move to a market economy.

Agriculture remains the main front of us.

We need agriculture to export of rice, bring

money for raw materials and machinery.

-> For agriculture and earn money to createeconomic growth in Vietnam.

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Two Sector Model

Recognize the prime importance of labor and capital in

the growth process

Explore differences in both the levels and growth rates

of productivity in different activities and theimplications for relative wages

Include:

- The 2-Sector Labor-Surplus Model (Lewis Classical

Model)- The Neoclassical Two-Sector Model

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The 2-Sector Labor-Surplus Model

(The Lewis Classical Model)

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Fig. 4.10: The Supply and Demand for Industrial labor

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The Lewis Classical Model

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The Neoclassical Two-Sector Model

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The Neoclassical Two-Sector Model

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The Differences implications in

neoclassical and classical model

Classical model

Population growth is a

negative effect.

Neoclassical

Population growth is not a

negative effect.

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Thank you for attention!

Documents

Group 4 Economic Theory