Presentation on theme: "mankiw's macroeconomics modules"— Presentation transcript:
1 mankiw's macroeconomics modules A PowerPointTutorialto Accompany macroeconomics, 5th ed.N. Gregory MankiwMannig J. SimidianCHAPTER SEVENEconomic Growth I
2 The Solow Growth Model The Solow Growth Model is designed to show how growth in the capital stock, growth in the labor force, and advances in technology interact in an economy, and how they affect a nation’s total output ofgoods and services.Let’s now examine how themodel treats the accumulationof capital.
4 The Production Function Let’s analyze the supply and demand for goods, andsee how much output is produced at any given timeand how this output is allocated among alternative uses.The Production FunctionThe production function represents the transformation of inputs (labor (L), capital (K), production technology) into outputs (final goods and services for a certain time period).The algebraic representation is:Y = F ( K , L )Key Assumption: The Production Function has constant returns to scale.zissome function ofour given inputsIncome
5 Constant Returns to Scale This assumption lets us analyze all quantities relative to the size of the labor force. Set z = 1/L.Y/ L = F ( K / L , 1 )issome function ofthe amount of capital per workerOutputPer workerConstant returns to scale imply that the size of the economy asmeasured by the number of workers does not affect the relationshipbetween output per worker and capital per worker. So, from now on,let’s denote all quantities in per worker terms in lower case letters.Here is our production function: , where f(k)=F(k,1).y = f ( k )
6 y k Marginal Product of Capital (MPK): The Slope of the Production FunctionMPK = f (k + 1) – f (k)The production function showshow the amount of capital perworker k determines the amountof output per worker y=f(k).The slope of the production functionis the marginal product of capital:if k increases by 1 unit, y increasesby MPK units.ykDiminishingMarginalProduct of Capitalf(k)MPK1
7 The Demand for Goods and the Consumption Function y = c + i1)Outputper workerconsumptionper workerinvestmentper workerc = (1-s)y2)savingsrate(between 0 and 1)consumptionper workerdependsony = (1-s)y + i3)Investment = savings. The rate of saving sis the fraction of output devoted to investment.4)i = sy
8 Growth in the Capital Stock and the Steady State Here are two forces that influence the capital stock:Investment: expenditure on plant and equipment.Depreciation: wearing out of old capital; causes capital stock to fall.Recall investment per worker i = s y.Let’s substitute the production function for y, we can express investmentper worker as a function of the capital stock per worker:i = s f(k)This equation relates the existing stock of capital k to the accumulationof new capital i.
9 Output, Consumption and Investment The saving rate s determines the allocation of output betweenconsumption and investment. For any level of k, output is f(k),investment is s f(k), and consumption is f(k) – sf(k).ykOutput, f (k)y (per worker)c (per worker)Investment, s f(k)i (per worker)
10 DepreciationImpact of investment and depreciation on the capital stock: Dk = i –dkChange inCapital StockInvestmentDepreciationRemember investment equalssavings so, it can be written:Dk = s f(k)– dkdkkdkDepreciation is therefore proportionalto the capital stock.
11 The Steady State, k* Investment and Depreciation Depreciation, d k The long-run equilibrium of the economyInvestmentand DepreciationDepreciation, d kAt k*, investment equals depreciation and capital will not change over time.Below k*, investment exceeds depreciation, so the capital stock grows.Investment, s f(k)i* = dk*Above k*, depreciation exceeds investment, so the capital stock shrinks.k1k*k2Capitalper worker, k
12 How Saving Affects Growth The Solow Model shows that if the saving rate is high, the economywill have a large capital stock and high level of output. If the savingrate is low, the economy will have a small capital stock and alow level of output.InvestmentandDepreciationDepreciation, d kInvestment, s2f(k)Investment, s1f(k)i* = dk*An increase inthe saving ratecauses the capitalstock to grow toa new steady state.k1*k2*Capitalper worker, k
13 The Golden Rule Level of Capital The steady-state value of k that maximizes consumption is calledthe Golden Rule Level of Capital. To find the steady-state consumptionper worker, we begin with the national income accounts identity:and rearrange it as:c = y - i.This equation holds that consumption is output minus investment.Because we want to find steady-state consumption, we substitutesteady-state values for output and investment. Steady-state outputper worker is f (k*) where k* is the steady-state capital stock perworker. Furthermore, because the capital stock is not changing in thesteady state, investment is equal to depreciation dk*. Substituting f (k*)for y and d k* for i, we can write steady-state consumption per worker asc*= f (k*) - d k*.y - c + i
14 Steady-state Consumption c*= f (k*) - d k*.According to this equation, steady-state consumption is what’s leftof steady-state output after paying for steady-state depreciation. Itfurther shows that an increase in steady-state capital has two opposing effects on steady-state consumption. On the one hand, more capital means more output. On the other hand, more capital also means that more output must be used to replace capital that is wearing out.The economy’s output is used for consumption or investment. In the steady state, investment equals depreciation. Therefore, steady-state consumption is the difference between output f (k*) and depreciation d k*. Steady-state consumption is maximized at the Golden Rule steady state. The Golden Rule capital stock is denoted k*gold, and the Golden Ruleconsumption is c*gold.dkkOutput, f(k)c *goldk*gold
15 Let’s now derive a simple condition that characterizes the Golden Rule level of capital. Recall that the slope of the production function is themarginal product of capital MPK. The slope of the dk* line is d.Because these two slopes are equal at k*gold, the Golden Rule canbe described by the equation: MPK = d.At the Golden Rule level of capital, the marginal product of capitalequals the depreciation rate.Keep in mind that the economy does not automatically gravitate towardthe Golden Rule steady state. If we want a particular steady-state capitalstock, such as the Golden Rule, we need a particular saving rate tosupport it.
16 Population GrowthThe basic Solow model shows that capital accumulation, alone,cannot explain sustained economic growth: high rates of savinglead to high growth temporarily, but the economy eventuallyapproaches a steady state in which capital and output are constant.To explain the sustained economic growth, we must expand theSolow model to incorporate the other two sources of economicgrowth.So, let’s add population growth to the model. We’ll assume that thepopulation and labor force grow at a constant rate n.
17 The Steady State with Population Growth Like depreciation, population growth is one reason why the capitalstock per worker shrinks. If n is the rate of population growth and dis the rate of depreciation, then (d + n)k is break-eveninvestment, which is the amount necessaryto keep constant the capital stockper worker k.Investment,break-eveninvestmentCapitalper worker, kk*Break-eveninvestment, (d + n)kInvestment, s f(k)For the economy to be in a steady state investment s f(k) must offset the effects of depreciation and population growth (d + n)k. This is shown by the intersection of the two curves. An increase in the saving rate causes the capital stock to grow to a new steady state.
18 The Impact of Population Growth An increase in the rate of population growth shifts the line representing population growth and depreciation upward. The newsteady state has a lower level of capital per worker than the initial steady state. Thus, the Solow modelpredicts that economies with higher ratesof population growth will have lowerlevels of capital per worker andtherefore lower incomes.Investment,break-eveninvestmentCapitalper worker, kk*1Investment, s f(k)(d + n1)kk*2(d + n2)kAn increase in the rate of population growth from n1 to n2 reduces the steady-state capital stock from k*1 to k*2.
19 Population Growth (n)The change in the capital stock per worker is: Dk = i –(d+n)kNow, let’s substitute sf(k) for i: Dk = sf(k) – (d+n)kThis equation shows how new investment, depreciation, and population growth influence the per-worker capital stock. New investment increases k, whereas depreciation and population growth decrease k. When we did not include the “n” variable in our simple version– we were assuming a special case in which the population growth was 0.
20 In the steady-state, the positive effect of investment on the capital per worker just balances the negative effects of depreciation and population growth. Once the economy is in the steady state, investment has two purposes:Some of it, (dk*), replaces the depreciated capital,The rest, (nk*), provides new workers with the steady state amount of capital.Break-even investment,(d + n') ksf(k)Break-even Investment,(d + n) kThe Steady StateAn increase in the rate of growth of population will lower the level of output per worker.Investment,s f(k)k*'k*Capitalper worker, k
21 Final Points on SavingIn the long run, an economy’s saving determines the sizeof k and thus y.The higher the rate of saving, the higher the stock of capitaland the higher the level of y.An increase in the rate of saving causes a period of rapid growth,but eventually that growth slows as the new steady state isreached.Conclusion: although a high saving rate yields a highsteady-state level of output, saving by itself cannot generate persistent economic growth.
22 Key Concepts of Ch. 7Solow growth model Steady state Golden rule level of capital