1. Lecture 3: Key Facts About Economic Growth L11200 Introduction to Macroeconomics 2009/10 Reading: Barro Ch.3 : p36-52 28 January 2010

2. Introduction So far: introduction and measurement – Two main topics: growth and fluctuations – Key macroeconomic variables and their measurement This Time: begin first topic: economic growth – More empirical evidence on cross-county growth – Basics of the growth model

3. Economic Growth Begin today with some evidence on economic growth. Key questions: – Why are some economics more ‘developed’ than others? – Why do GDP growth rates vary across nations? – What is the relationship between the level of GDP and the growth rate of GDP?

4. Summary Wide variation in real GDP per person – small group of nations with very high real GDP Over last 40 years some ‘winners’ and ‘losers’ – Winners: China, S. Korea, Taiwan – Losers: Congo, Niger, Angola Higher-GDP nations don’t show fastest growth – Middle-GDP nations tend to grow fastest – Some perpetually poor / low growth nations

5. Poverty and Inequality Distribution of world income is very unequal – Nearly all U.S. population have standard of living above that of nearly all Chinese population One way to measure poverty is by some common benchmark: $1 per day – By this measure poverty has fallen greatly over last 30 years – Majority of India, China lifted out of poverty, majority of Nigeria still in poverty

6. Basics of a growth model In microeconomics we model output as a function of inputs: capital (K) and labour (L) Add ‘technology’, denoted by ‘A’, in this form: Functional form is critical here – It determines the marginal products of the inputs – Plus the returns to scale of the inputs

7. Basics of the growth model For capital and labour assume diminishing marginal product plus constant returns to scale – If we double capital and labour, output doubles – If we increase capital independent of labour, each marginal increase gives less addition to output For technology: assume technology is a level parameter: if A doubles, output doubles

8. Functional Form Cobb-Douglas function has these properties – Where α is the capital share in production – Simple concept: how important is capital, relative to labour, in making the output – If α=1 then only capital matters in production – Idea: if I increase K by 1 unit, the effect on Y depends on how important K is in production

9. So output growth is given by: ‘rate of growth of output depends on the rate of growth of technology, plus the rate of growth of capital and labour weighted by their shares in production’ Initially assume

10. GDP per worker Interested in GDP per worker, growth rate of GDP per worker = growth rate of real GDP – growth rate of labour growth rate of capital per worker = growth rate of capital – growth rate of labour i.e. if Y is growing at 5%, but L is growing at 5%, then the growth is Y/L is zero.

11. Growth in GDP per worker Output growth is given by: So, this equation is simply: Growth rate of capital per workerGrowth rate of GDP per worker

12. To get per capita output growth, you need to increase capital per worker – This makes each worker more productive, so increases output per worker – Doubling number of machines and workers doesn’t change output per work (because of CRS) – Adding just workers lowers k and so causes output per worker to fall Key result: GDP per worker can only be increased by adding more capital input

13. Summary Levels / growth of per capita GDP vary greatly across nations In general, levels of poverty have improved over last 30 years We began a basic model of GDP Key insight: GDP per worker can only be increased by adding capital to production (in a world without technology growth)