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 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 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 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 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 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 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 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 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 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 = 0.925% pa was mostly due to technological progress

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 = 3.925% pa of the per capita output growth  Which country is performing better? Production Function

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 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 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 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 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 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 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 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 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 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 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 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 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 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 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 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 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 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 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 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 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 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