ECO202Y - Lecture 8 (for final).pdf

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Masoud Anjomshoa

✤ Solow Growth Model has three components: per worker production function (real functions), per worker investment/saving function (real function), per worker balanced investment line (hypothetical situation)▯ ✤ What happens if any components of the model change?▯ ✤ Endogenous and Exogenous variables▯ ✤ We are going to change the exogenous variables one by one to see what their effects are▯ ✤ In the simple Solow Model, we assume that productivity is constant▯ ✤ Intersection between actual investment per worker and balanced investment per worker leads to the steady state▯ ✤ Use the intersection point to lead to the production function to find the output per worker or income per worker▯ ✤ If we are at the steady state, we are at a stable economic equilibrium▯ ✤ This means that we are at the steady state, there are not any economic forces that will make us move from that position; and if we are not at the steady state, there will be economic forces that will make us approach the steady state▯ ✤ The K:L can fall below the steady state for two reasons:▯ ✤ 1. the capital could decline 2. the labour force could increase▯ ✤ A fall in the K:L ratio results in the reduction of output/income per worker, and therefore the productivity▯ ✤ Implication of balanced investment > actual investment => capital stock will start to rise => K/L will rise => income per worker starts to recover▯ ✤ As K/L and income rise: 1.) actual saving/investment increase along the per worker line, 2.) balanced investment line, has also increased▯ ✤ Actual investment > Balanced investment = as long as we are still investing, the K/L ratio will rise some more, and eventually we will get to the original K/L▯ ✤ Economic output per worker goes back to its original level, saving and actual investment continue to increase until they get back to their original value, balanced investment also moves▯ ✤ When actual investment = balanced investment▯ ✤ = steady state▯ ✤ ^^ Example: recovery from the Earthquake▯ ✤ ^^ assuming that productivity is constant▯ ✤ How do we know if the economy grows more equally between two cases?▯ ✤ 1. when we are at k/L1, we have a huge gap between actual & balanced investment ▯ ✤ As we move closer to the steady state, the gap between actual & balanced investment gets smaller = change in economic activity will be lesser▯ ✤ 2. Per worker production function has diminishing returns to capital - so as K:L rises from a relatively low of level, the increase in income per worker will be on the steeper part of the production function and income per worker will rise a lot▯ ✤ as we get closer to the steady state, further increases only increases a little slowly▯ ✤ Magnitude in change in
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