1. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. Chapter 7 Endogenous Growth

2. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-2 Chapter 7 Topics Endogenous growth: a model of human capital accumulation The Solow model predicts that sustained growth in z can lead to sustained economic growth. Endogenous growth model answers the question of how to obtain sustained growth in z.

3. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-3 Endogenous Growth: A Model of Human Capital Accumulation In this model, the growth rate of per capita income is determined by the efficiency with which human capital is accumulated, and the fraction of available time devoted to human capital accumulation. Time allocation –Work –Human capital accumulation (education attainment) Tradeoff between current and future growth caused by human capital accumulations.

4. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-4 Property of Human Capital - Nonrivalry A particular person’s acquisition of knowledge does not reduce the ability of someone else to acquire the same knowledge. In contrast, physical capital investment is rivalrous: acquiring equipment by one firm uses up resource and limits the number of equipment available to other firms. Lack of diminishing returns to scale leads to unbounded growth in the endogenous growth model.

5. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-5 Equation 7.1 Consumption is equal to total wage income. uH s : efficiency unit of labor. H s : number of current period human capital stock. u: time devoted in working in each period. There is no saving, excluding investment in physical capital.

6. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-6 Equation 7.2 – Human Capital Accumulations Future human capital depends on current human capital and time devoted to training and education. b: efficiency of HC accumulation process, exog. parameter. 1-u: time devoted in acquiring HC.

7. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-7 Equation 7.3: Production Function

8. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-8 Equation 7.4: Firm’s Profits 1. If z < w, H d =0. 2. If z > w, H d goes to infinity. 3. If z = w, H d can be any number. That is, firms are indifferent in H d

9. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-9 Figure 7.5 Determination of the Equilibrium Real Wage in the Endogenous Growth Model

10. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-10 Equation 7.5 Equilibrium Consumption:

11. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-11 Equation 7.6 Human capital evolves in equilibrium according to:

12. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-12 Equation 7.7 Equilibrium growth rate of human capital: Growth rate of HC depends on b, u.

13. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-13 Figure 7.6 Human Capital Accumulation in the Endogenous Growth Model

14. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-14 Figure 7.7 Effect of a Decrease in u on the Consumption Path in the Endogenous Growth Model If u decreases: Consumption drops in current period. Growth rate in C increases, leading to higher consumption in future period.

15. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-15 Figure 7.8 No Convergence in the Endogenous Growth Model

16. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-16 Model Fit - Convergence Consistent with data in the sense that there exists persistent gap in income per capita between poor and rich countries. Inconsistent with data in the sense that there exists convergence in income per capital among rich countries.

17. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-17 Human Capital Externalities HC externality exists when labor and capital are mobile since mobility of L and K facilitates skill transfer across countries, therefore, enhance human capital accumulations in relative poor countries.