ECO202Y - Lecture 7 (note for final).pdf

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Masoud Anjomshoa

✤ So far: production function, demand/supply of labour, labour market LR = FE, employment and our production function can determine the the FE output level▯ ✤ FE = Full Employment▯ ✤ How real interest rates are set in LR = desired investment/saving in the economy, national saving accounting in LR, open and closed economies (Lec 5 & 6)▯ ✤ What actually accounts for economic growth over long periods of time?▯ ✤ = 1. how do we assign responsibility for economic growth to various factors in the economy that might generate economic output▯ ✤ = 2. is there a way in which we can model economic growth in the LR so we can explain a wide variety of economic circumstances that take place amongst the various countries of the world over different time periods?▯ ✤ Three goals: ▯ ✤ 1. how important long term economic growth for standards of living in a given country ▯ ✤ 2. how we can account for that growth - what are the factors that are causing an economy to grow very rapidly or not so rapidly (Stagnation)▯ ✤ 3. set up a model which would be general enough to allow us to explain why changes in economic growth in LR actually take place▯ ✤ Long term economic growth = average annual rate of growth over a long period of time▯ ✤ important to consider = the population and therefore the labour force will also be growing over the years, and we know from our production function that if we have more workers, we will have a higher output level (and we want to ignore that fact for our analysis)▯ ✤ Income per worker (Y) and capital per worker (X) graph▯ ✤ LR growth = small changes over a long period of time can make a huge difference▯ ✤ **Convergence**▯ ✤ Economy’s profuction function = Y=AF(K,N)▯ ✤ Growth accounting formula = the rate of economic growth = deltaY/Y = deltaA/A + akdeltaK/K + andeltaN/N▯ ✤ ak, an = out elasticity of labour and capital = marginal product of labor and capital = sum to 1 (MPL and MPK <1 because of diminishing MP)▯ ✤ economic (residual) productivity = economic output - contribution from K & L (= SOLOW RESIDUAL)▯ ✤ growth accounting formula = allows us to examine the sources of growth as the changes in factors of growth = how fast an economy grows over time = contributions from productivity, K, & L▯ ✤ **changes in productivity rate is the most important (discussed in next lecture)▯ ✤ But lets not forget that the labour force is also growing over time, ▯ ✤ Ex, if for example China’s economy is growing by 10%, and their labour force grew by 20%, it wouldn’t be hard to believe (because otherwise, although they were growing very quickly, income per worker would have fallen)▯ ✤ Likewise, if the the economy’s growth rate is 10%, and the labour force grows by 1%, the increase in income per worker is 9%▯ ✤ ^^ we want to concentrate on income per worker - which is the focus of the Solow growth model▯ ✤ In explaining economic growth rate, Solow knew that capital accumulation was important▯ ✤ ^ he knew that because countries who were really poor didn’t have much capital, countries who were very rich has a lot of capital▯ ✤ Solow’s Hypothesis: ▯ ✤ 1. Level of capital was very important to explaining the level of income per worker▯ ✤ 2. Then, where does capital come for? Capital is built by making investments in productive assets?▯ ✤ 3. Where does investment come from? Savings!!▯ ✤ == what is taking place with the saving rate? = do countries save a lot or save very little? because that going to tell us about how much investment activity can take place, and therefore how much capital can be accumulated▯ ✤ Capital accumulation is directly related to economic growth rate▯ ✤ Other observations = countries which were growing rapidly were poorer (low income)▯ ✤ = middle income countries = slower population growth rate than poorer countries▯ ✤ - high income countries = relatively slow population growth rate middle countries▯ ✤ Therefore, the economic growth rate depends on how much capital accumulation has taken place, as well as the population growth rate▯ ✤ Saving growth rate + population growth rate▯ ✤ Assumptions:▯ ✤ 1. labour force growth rate were constant▯ ✤ 2. no productivity growth▯ ✤ Production Function Y = K + L (t-subscript = time)▯ ✤ Technology = “knot” subscript▯ ✤ Divide the production function with labour force: now we have the production per worker = also the income per worker▯ ✤ Why do we not divide tech or productivity by labour force? = because productivity is set of ideas of how to use capital and labour to produc
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