ECON10003 Lecture Notes - Lecture 19: Portfolio Investment, Capital Account, Real Interest Rate
19 Jun 2018
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MACROECONOMICS WEEK 10
Implications of the Solow-Swan Model of Economic Growth
The steady state: long-run tendency towards steady state- a zero growth outcome. This is where capital labour ratio
and output(income) per head have both reached a level such that all available savings are needed to maintain the
capital labour ratio at that level. The steady state occurs because of diminishing marginal product of capital. As the
capital labour ratio increases, resulting increases in output/income per head becomes smaller and smaller so that
additional savings generated by these rises in income become sufficient only to provide for replacement investment.
As capital labour ratio increases the need for replacement investment also increases. Therefore, the economy’s savings
and therefore investment, is only sufficient to keep the capital labour ratio from changing. i.e. savings = replacement
investment.
A change in the savings ratio : A change in the savings rate will only provide for growth until the new steady state
is reached. When increased, at the existing steady state there is more savings than necessary to satisfy replacement
investment. So there can now be net investment to increase the capital labour ratio and output per head.
Convergence: Assuming a constant steady state between countries, less developed economies will see economies
growing at a faster rate. There is the same production function (A), rate of population growth (n), rate of depreciation
(d), and savings rate ().
Convergence Hypothesis Empirical Prediction: under the convergence hypothesis, there will be a negative
relationship between initial (base year) y and the subsequent economic growth.
Problems with Solow-Swan: 1. There is a limit to economic growth- where the steady state is reached. Economic
growth can only continue if productivity (A) increases. The savings rate, rate of population growth and rate of
depreciation are all limited. 2. The model has economic growth primarily depending on growth in the capital labour
ratio.
Endogenous Growth Models: Focus on providing an explanation for TFP. Human capital is important in the growth
process- embodied skills, education and training of the labour force. Various factors influencing TFP will be inter-
related e.g. proper education and infrastructure to utilise education. Long run growth is the continuous shift to the
right of the steady-state due to increasing TFP.
MACROECONOMICS WEEK 10
The Balance of Payments
The balance of payments: accounting record of the value of a country’s international economic or financial
transactions. Records all transactions into a country by non-residents to residents (households, business firms and
governments) and out of a country by residents to non-residents. Determines the supply and demand for a country’s
currency. E.g. Australia buying from France is a demand for euros and a supply of AUD.
Two accounts: Current account and capital and financial account.
Payments entering a country is recorded as a credit item, entering the accounts with a positive sign. Payments of funds
out of a country is recorded as a debit item, entering the accounts with a negative sign.
The current account: records payments made and received for currently provided goods and services.
Income: income earned by residents from non-residents, and income earned by non-residents from residents.
Including interest income paid on foreign borrowings and profits paid to foreign shareholders, and
compensation of employees as payments for the use of foreign labour i.e. all Primary income. Secondary
income records real resources or financial items provided without anything being provided in return by the
recipient. E.g. pensions, foreign aid.
Goods and Services: Payments made from imports and those received for exports of G&S. Difference
between payments is called Balance on Goods and Services.
The capital and financial account: records the payments made and received for purposes of acquiring or disposing
of a foreign (largely financial) asset or liability.
Capital account: includes capital transfers and the acquisition/disposal of non-produced, non-financial assets
e.g. patents, copyrights.
Financial Account: include recorded transactions associated with the change of ownership of Australia’s
foreign financial assets and liabilities. (Which can be distinguished as debt instruments and as equities)
An increase in liabilities is recorded as a credit item and a decrease in liabilities is recorded as a debit item.
find more resources at oneclass.com
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Document Summary
Implications of the solow-swan model of economic growth. The steady state: long-run tendency towards steady state- a zero growth outcome. This is where capital labour ratio and output(income) per head have both reached a level such that all available savings are needed to maintain the capital labour ratio at that level. The steady state occurs because of diminishing marginal product of capital. As the capital labour ratio increases, resulting increases in output/income per head becomes smaller and smaller so that additional savings generated by these rises in income become sufficient only to provide for replacement investment. As capital labour ratio increases the need for replacement investment also increases. Therefore, the economy"s savings and therefore investment, is only sufficient to keep the capital labour ratio from changing. i. e. savings = replacement investment. A change in the savings ratio : a change in the savings rate will only provide for growth until the new steady state is reached.
