Macroeconomics

Week 2

Growth (Continued)

Malthusian Growth
Prior to 1800 there was a long period of prolonged growth. The economic growth
at this time would match exactly the population growth per capita.

This could be explained since newer technological developments caused

mortality rates to decrease and fertility levels to grow. Thus, population grows to

match output

Eventually after the 1800s, we had the Industrial Revolution which created a
huge growth in output and a huge growth in population however this was less
than that of output. Fertility rates also fell.

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Production
Modern Models of economic growth are built upon a model of looking at
production and its decisions that impact on the resources available.

The factors of output in production are:

- Labour
- Capital
- Technology
- (Raw Materials)

Production Function
This is the base model used to represent the growth and production of a
economy.
Y = A∗F ( K∗N )
Where:
Y = Aggregate Output, N = Labour Inputs, K = Capital Inputs, F = Function
conversion from input to output, A = Total factor productivity A >0

The features of the curve are:

- If marginal product of labour MPN is positive:
o Increase in labour inputs N → increases total output

- MPN is decreasing in N:
o Additional units of labour should be added at a decreasing rate

- MPK marginal product of capital is positive:

o Increase in capital K → increases total output

- MPK decreasing in K

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 o Additional units of capital should be added at a decreasing rate

Cobb -Douglas Production Function

The Cobb Douglass production function is a variant of the production function.

θ 1−θ
Y=A K N
Where 0 ≤ θ ≤ 1

The Cobb Douglas function also represents technology as well.

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Average Product
Some ratios can be used to calculate the averages.

Growth Accounting
θ 1−θ
Y=A K N can be transformed to growth rate form, which allows us to see the
relationship between input growth and output growth.

Where:
dA dK dN
= Growth in productivity, = Growth in capital stock, growth in labour
A K N
supply

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Solow Growth Model
A model of production and investment that provides insight into the drives of
economic growth.

Capital determines output:

Y t = At F (K t , N t )
↓
Output determines investment
I t=S t Y t where s is savings
↓
Investment determines future capital (capital accumulation)
Δ K t=( K t+ 1−K t )
Δ K t=I t −d K t where d is depreciation rate
↓
Population grows over time
Δ N t=N t +1−N t
Δ N t=n N t where n is population growth rate

Assumptions for this growth model

Capital → Output
The total capital is better captured by output per capita. Simply we divide the
capital by labour

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 Yt ( Kt)
= AF ,1 OR y t =Af ( k t )
Nt Nt

The Cobb Douglas version yields:

( )
θ
Yt K t 1−θ
=A 1
N❑t Nt
OR
θ
y t =A k t

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Output → Investment
Economy is assumed to be in (long-run) equilibrium: I = S every dollar saved is
used in investment

Let 0< s < 1 be the savings rate so that:

St =s Y t

as savings is = I then:
I t=s Y t

We can then divide by N to get our investment per capita:

i t =s y t

Investment Determines Accumulation

Δ K t=I t −d K t
The investment level needed to maintain a given level of K depends on the
population growth rate and the depreciation rate.

Therefore, the equation is rearranged to accommodate for this:

Δ k t =it −( d + n ) k t
Where d = depreciation rate and n = population growth rate

Recall that savings = investment, then:

Δ k t =sf ( k t ) −( d +n ) k t

Summary

Where C is consumption

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We need to also add the maintenance cost for capital, which is increasing with K

Maintenance cost intersects with the investment cost at ΔK = 0

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Final Form
The final form of the Solow growth model also includes the change in capital. It
plots the distance of the gap between the maintenance line and the investment
line (green) (yellow) respectively.

Steady State
This is the area when ΔK = 0 the economy is in a steady state when the per
capita income and capital are constant. We denote this as k*

This is the point were for every worker we would assume per cappita:

For economies that begin at levels before k* i.e. (k<k*) they will converge
towards k* as capital accumulates.

For economies that begin at levels greater than k* i.e. (k>k*) then they will also
converge towards k* due to existing capital stock depreciating and dispersing.

All economies will move towards convergence.

Highly developed economies develop slower.
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 Lower development economies develop faster.

Convergence
We should observe the same steady state level of output across all countries that
have:
- Similar saving rates
- Similar depreciation rates
- Similar population and growth rates
- Spillover of new technologies across borders

Smaller countries will grow faster due to greater accumulation and capital should
flow from big to small economies since they have a higher Marginal Product of
Capital

Limits of the Solow model

Sometimes we do observe differences in rates of growth, however these could be
due to increase in technology (A), Change in propensity to save (S)

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