1. Principles of Macroeconomics
Economic Growth

2. Economic Growth Learning Objectives
Difference between Keynesian and Classical Growth
Initiating growth under capital excess capacity and capital scarcity.
70s Rule of Growth
Vicious Cycle of Poverty
Malthusian Growth

3. Economic Growth The Need for Growth and the Concept of Growth
Population grows, therefore the economy as a whole must grow in order to avoid that we all get poorer in per capita income terms.
Methodologically, economists associate with growth either a movement from a point of inefficiency to the PPF or an outward shift of the PPF.

4. Economic Growth
Economic Growth – Short vs. Long Run

5. Economic Growth Determinants of Growth Keynesian Growth
Classical Growth
Growth=F(Aggregate Demand)
Growth=F(TFP, Capital, Labor)
Aggregate Demand changed by Fiscal and Monetary Policy
TFP=Total Factor Productivity, changed by institutions like
Political Regime
Quality of Governance
Saving
Population Growth Rate
Trust within society
And the like

6. Economic Growth Growth in the Keynesian World
The economy is assumed to be in an “underemployment equilibrium,” which is only possible because wages cannot adjust.

7. Economic Growth Growth in the Keynesian World
The basic idea: Because wages are assumed to be sticky, government needs to stimulate aggregate demand with fiscal and monetary policy.

8. Economic Growth
Growth in the Keynesian World (Assumption: Excess Capacity)
Stylized Example:
Period C G I Y
1 (Starting Point) 50 30 20
100
2 (Recession) 40 10 80
3 (Stimulus)
55 (30+25) 5
4 (Back to normal)
30 (50-25)

9. Economic Growth Criticism of the Keynesian approach:
Crowding out of private investment.
Crowding out of private consumption: If government finances public expenditures with bonds, people expect to be taxed later and therefore consume less (Ricardian equivalence: Both taxation and debt financing reduces private consumption).
It’s often politically difficult to end again a stabilization program.

10. Economic Growth The power of compounding (Rule of 70)
How long does it take for something to double its initial value at a growth rate r%?
Answer: 70/r
Proof:
Take log:
Note that ln(1+r/100)r (for small r) and ln2=0.693
Then,

11. Economic Growth The Vicious Cycle of Poverty Too Poor to Save
Too Little Investment
Too Little Income

12. Economic Growth
Growth in Underemployment (Assumption: Capital shortage)
There is a constant capital-output ratio,
Rearrange to
How does the economy grow over time?
Intuition: If more unemployed can be linked to extra capital, the change in the capital stock over the constant capital output ratio defines the change of output over time. This is written as
Because , and the growth rate

13. Economic Growth Sample questions:
A poor country operates with a capital-output ratio of g=3. The savings rate is 9%. At what rate does the economy grow?
Assuming that the population grows at 3%, at what rate does GDP per capita grow?
How many years does it take for GDP and GDP per capita to double?
Holding g constant, what would the savings rate have to be, so that GDP grew at 5%?

14. Economic Growth Sample questions:
A poor country operates with a capital-output ratio of g=3. The savings rate is 9%. At what rate does the economy grow?
Assuming that the population grows at 3%, at what rate does GDP per capita grow?
How many years does it take for GDP and GDP per capita to double?
Holding g constant, what would the savings rate have to be, so that GDP grew at 5%?