1. 1 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson Chapter 3 Growth and Accumulation

2. 2 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson Chapter Organisation 3.1Growth Accounting 3.2Empirical Estimates of Growth 3.3Neoclassical Growth Theory 3.4Convergence 3.5Exogenous Technological Change

3. 3 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson 3.1 Growth Accounting  Growth accounting explains:  the contribution of factors of production  to the growth in total output  The production function is Y = AF (K, N)(3.1)  It shows the quantitative relationship between factor inputs and output capital labour

4. 4 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson Y = AF (K, N)(3.1)  The production function shows that output is positively correlated with:  the marginal product of labour (MPN) defined as  Y/  N  the marginal product of capital (MPK) defined as  Y/  K  technology given by the parameter A Production Function

5. 5 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson  Transforming Y = AF (K, N) to measure growth rates gives equation (3.2) Production Function Output growth labour growth capital growth Labour share Capital share Technical progress

6. 6 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson  Transforming Y = AF (K, N) to measure growth rates gives equation (3.2) Production Function Output growth labour growth capital growth Labour share Capital share Technical progress

7. 7 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson Production Function  The contribution of labour and capital to output equals  their individual growth rates  multiplied by the share of that input towards output  The third term is total factor productivity (TFP), which measures the rate of technical progress

8. 8 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson Production Function  Subtracting population growth  N/N from both sides gives (3.4)

9. 9 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson Production Function  The parameter  usually has a value of 0.25 for Australia  For the period 1950–92 in Australia  the average annual growth rate of per capita capital was 4.3% pa  the average annual growth rate of per capita output was 2.0% pa (3.4)

10. 10 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson Production Function  Equation 3.4 shows that  per capita capital growth of 4.3% pa contributed 0.25  4.3% = 1.075% pa to per capita output growth  the recorded per capita output growth was 2.0% pa.  The remaining per capita output growth of 2.0 - 1.075 = 0.925% pa was mostly due to technological progress

11. 11 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson  The comparable figures for Japan are  per capita capital growth of 7.1% pa contributed 0.25  7.1% = 1.775% pa to per capita output growth  The recorded per capita output growth was 5.7% pa  technological progress was responsible for 5.7 - 1.775 = 3.925% pa of the per capita output growth  Which country is performing better? Production Function

12. 12 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson Production Function  Compare these per capita growth rates (%)

13. 13 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson Chapter Organisation 3.1Growth Accounting 3.2Empirical Estimates of Growth 3.3Neoclassical Growth Theory 3.4Convergence 3.5Exogenous Technological Change

14. 14 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson 3.2 Empirical Estimates of Growth  The simple production function Y = AF (K, N)(3.1)  Ignores important factor inputs which also affect economic growth  Other possible factor inputs are  natural resources  public infrastructure capital  human capital

15. 15 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson Empirical Growth Estimates

16. 16 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson  History has shown the two most important factors that increase GDP are  capital accumulation (physical and human)  technical progress  Incorporating human capital (H) into the production function gives Y = AF (K, H, N)(3.5)  Important to distinguish labour endowment (N) from acquired human capital skills (H) Empirical Growth Estimates

17. 17 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson Chapter Organisation 3.1Growth Accounting 3.2Empirical Estimates of Growth 3.3Neoclassical Growth Theory 3.4Convergence 3.5Exogenous Technological Change

18. 18 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson 3.3 Growth Theory: The Neoclassical Model  Growth theory attempts to explain  how economic decisions affect the accumulation of the factors of production  why some nations such as the US and Japan have grown rapidly over the last 150 years  while other nations such as Bangladesh have experienced virtually zero growth

19. 19 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson  Initially, neoclassical growth theory assumes there is no technical progress  This implies that the economy will reach a steady-state equilibrium  where per capita GDP and per capita capital remain constant  per capita capital cannot grow endlessly because of diminishing marginal product of capital  the economy, therefore, reaches a steady-state equilibrium Neoclassical Growth Theory

20. 20 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson  In a steady state the level of investment required to maintain per capita capital depends on  population growth (n =  N/N)  the depreciation rate (d)  The economy needs investment to maintain the level of per capita capital  nk to provide capital for new workers  dk to replace existing capital  total investment requirement is (n + d)k Neoclassical Growth Theory

21. 21 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson  Assume  constant population growth (n) and depreciation (d)  a closed economy  there is no government sector  savings are a constant fraction (s) of income (s is APS)  total per capita savings are therefore sy = sf (k) Neoclassical Growth Theory

22. 22 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson  These assumptions give  steady-state equilibrium (y* and k*)  where per capita savings equals investment sy* = sf (k*) = (n + d)k*  This relationship is represented in Figure 3.4  the saving relationship sf (k*) is the (concave to the k axis) production function  the investment relationship (n + d)k* is the straight ray from the origin Neoclassical Growth Theory

23. 23 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson  Consider Figure 3.4  When saving exceeds investment required  sf (k 0 ) > (n + d)k 0  per capita capital increases from k 0 to k*  Beyond point C  diminishing MPK ensures savings are less than the required investment  sf (k 0 ) < (n + d)k 0  per capita capital decreases to k* Neoclassical Growth Theory

24. 24 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson Neoclassical Growth Theory

25. 25 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson  Hence, the economy reaches a steady state at point C  This implies that steady-state growth rate is not affected by the level of savings  In the long run an increase in the rate of savings  raises the long-run level of capital and output per capita  but not the growth rate of output Neoclassical Growth Theory

26. 26 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson Chapter Organisation 3.1Growth Accounting 3.2Empirical Estimates of Growth 3.3Neoclassical Growth Theory 3.4Convergence 3.5Exogenous Technological Change

27. 27 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson 3.4 Convergence  Neoclassical growth theory predicts absolute convergence for economies with  equal rates of savings and population growth  access to the same technology  This model predicts conditional convergence for economies that differ in  rates of savings,  human capital development  or population growth

28. 28 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson Convergence  Conditional convergence means  steady-state per capita incomes differ  while per capita incomes growth rates equalise  Empirical evidence suggests that some nations have shown  divergence with poor countries growing slower than rich nations  absolute convergence for some nations with common characteristics  conditional convergence characteristics

29. 29 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson Chapter Organisation 3.1Growth Accounting 3.2Empirical Estimates of Growth 3.3Neoclassical Growth Theory 3.4Convergence 3.5Exogenous Technological Change

30. 30 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson 3.5 Exogenous Technological Change  The comparison of Australia and Japan shows the importance of technology

31. 31 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson Technological Change  We, therefore, allow technology to exogenously increase in the model  That is  A/A > 0  The function Y = AF (K, N) shows the technology effect as total factor productivity (TFP)  An alternative is labour-augmenting technology Y = F (K, AN)  We will stay with (TFP)

32. 32 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson Technological Change  The effect of exogenous increases in TFP on the neoclassical model is similar to an increase in savings  The new steady-state point is at an increasing per capita output and capital- labour ratio  However, the growth rate of per-capita output remains constant  It grows at the same constant TFP rate

33. 33 Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz Slides prepared by Ed Wilson Technological Change  The neoclassical growth model is an important reference  However the model’s assumptions and validity have been questioned  Endogenous growth theory has been developed to allow for more complicated and realistic endogenous increases in TFP