macro session 9

7/27/2019 Macro Session 9

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Macroeconomics & The

Global EconomyAce Institute of Management

Session 9: Economic Growth

InstructorRijan Dhakal

[email protected]

9851069004
mailto:[email protected]:[email protected]


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CHAPTER 7 Economic Growth Islide 1

The Solow or Neo Classical Model

A major paradigm by Robert Solow:

widely used in policy making

benchmark against which mostrecent growth theories are compared

The rate at which the output of the economy growsbasically depends on the rate at which the followingsgrow over time:

Capital Stock

Labour Force Technological Progress

Factors of Production

- Production Function


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The Solow Model- Accumulation of

Capital Stock in an Economy

How much capital an economy canaccumulate depends on:

supply of goods (Output) : depends on

Production function

demand for goods (Input): depends onConsumption function


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The production function

In aggregate terms: Y = F(K, L)

where Y= Output

K= Capital Stock

L= No. of Labour

Assumption: Constant return to scale. So,

zY = F(zK, zL) for any z> 0

Suppose, z= 1/L. Then,

Y/L = F(K/L, 1)

Output per worker (Y/L) is the function of capital

per worker (K/L) .


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Assume, Y/L = y and K/L = k. Then,

y = f(k). Ignore 1 as a constant.(i)

Eqn, (i) shows how much extra output a

worker produces given an extra capital(Marginal Product of Capital-MPK).


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Output perworker, y

Capital perworker, k

f(k)

Note: this production functionexhibits diminishing MPK.

1

MPK

Note:

When capital

per worker is

high, extra unit

of capital

produces lower

output

Vice Versa.


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The Demand for Goods and Services

y= c + i (remember, noG : Two Sector)

In per worker terms:

Output per worker is divided into consumption per worker

and investment per worker

Since people save and consume their income,

If savings rate = s, then, c = (1-s)

So, fraction of the income that people consume is

c = (1-s)y .. Consumption Fn.


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The Demand for Goods and Services

Substituting the value of c in y;

y= (1-s)y + i or

i = sy

Shows that investment equals saving where

s is the fraction of the output/ incomedevoted to investment.


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Basis of Neo-Classical Growth Model

The main building block of the model: production function(Y depends on K, L and the technological progress)

Investment : K

Depreciation : K

So, When I > D; K

When I < D; K

When I = D; K- Unchanged (Steady State)

Big Question: When does investment exceeddepreciation, and when does it fall short of it?


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Basis of Neo-Classical Growth Model

Depreciation: we may safely assume it as a constant(usually shown by 45 degree).

Investment:Can be shown in terms of savings.

Saving is a fixed share of total income. Therefore, savings

and/orinvestment at different capital stocks can bepresented as a part of the total output (Income).


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Graphical representation without Technology

Capital Per Worker

OutputPerWo

rker

Steady State


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Golden Rule level of Capital

Capital Per Worker

OutputPerWo

rker

Steady State

C*gold

I*gold

k*gold

The Golden Rule

level of capital

accumulation is

the steady state

with the highest

level of

consumption.


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CHAPTER 7 Economic Growth I slide 12

The model and increase in the saving rate

Capital Per Worker

OutputPerW

orker


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The model and increase in population


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Effect of Techno log ical Advancement

y = f(k)

ir= dk

i = s f(k)

k

y

k*

y*i = s' f(k)

k1*

y* y = f(k)

Productivity perworker increases

Shifts the

Production

functions upward

Saving rate shifts

upward

Capital stock per

worker increases

New Steady State is

formed

Output per worker

is increased but

greater than k


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Policy issues:

How to increase the saving rate?

Reduce the government budget deficit(or increase the budget surplus).

Increase incentives for private saving.

Example: Reduce tax


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Policy issues:

Allocating the economys investment

In the Solow model, theres one type ofcapital.

In the real world, there are many types,which we can divide into three categories:

private capital stock public infrastructure

human capital: the knowledge and

skills that workers acquire througheducation.

How should we allocate investment amongthese types?


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Policy issues:

Allocating the economys investment

Two viewpoints:

1. Let the market allocate investment to the typewith the highest marginal product.

2. Industrial policy by government:Govt should actively encourage investment incapital of certain types or in certain industries,because they may have positive externalities

that private investors dont consider.


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Policy issues:

Establishing the right institutions

Creating the right institutions is important forensuring that resources are allocated to theirbest use. Examples:

Legal institutions, to protect property rights.

Capital markets, to help financial capital flow

to the best investment projects.

A corruption-free government, to promotecompetition, enforce contracts, etc.


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Thank You

macro session 9

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