CHAPTER 7: ECONOMIC GROWTH
➔ primary facts of economic growth and key macroeconomic models that
economists have used to understand these facts.
➔ Malthusian model of economic growth which states that population
growth increases with the standard of living (S.O.L), and that any
improvement in technology for producing goods leads to more
population growth, and in the long run there is no improvement in the
standard of living. This model explains economic growth in the world
prior to the industrial revolution, but not after. Capital accumulation
wasn’t envisioned in this model.
➔ In the Solow model of economic growth, capital accumulation plays an
important role. The model predicts long-run improvements in S.O.L
generated by improvements in technology. The model states that
countries with high savings rates tend to have high levels of per capita
income (and vice versa), and that countries with high levels of
population growth tend to have low levels of per capita income (and vice
➔ Growth accounting--an approach to attributing economic growth to
growth if factors and in productivity.
Economic Growth: Malthus and Solow
Before 1800, S.O.L differed little over time and across countries. However since
the industrial revolution, economic growth has not been uniform across
countries and there are wide disparities amongst countries of the world in
There also exist disparities between rates of growth amongst countries.
The Solow growth model is an exogenous model--that is, growth is caused in
the model by forces that are not explained by the model itself.
To gain a deeper understanding of economic growth, it is useful to examine the
economic factors that cause growth which is done in endogenous growth
Economic Growth Facts:
Key empirical regularities relating to growth within and across countries to
give us a framework for evaluating our models. The important growth facts
➔ Before the industrial revolution in about 1800, standards of living differed little over time and across countries. There were no
improvements in the standards of living for a long period of time prior to
➔ Since the industrial revolution , per capita income growth has been
sustained in the richest countries. In the United States, the average
annual growth in per capita income has been about 2% since 1900. The
slope of the natural log of a time series is approximately equal to the
➔ There is a positive correlation between the rate of investment and output
per worker across countries. Countries in which a relatively large
fraction of output is channeled into investment tend to have a relatively
high S.O.L (and vice versa).
➔ There is a negative correlation between population growth rate and
output per worker across countries. Countries with high population
growth rates tend to have low standards of living (and vice versa).
➔ Differences in per capita income have increased dramatically among
countries of the world between 1800-1950, with the gap widening
between countries of western europe, the United States, Australia,
Canada, and New Zealand (as a group) and the rest of the world. Are the
standards of living across countries converging? The industrial
revolution spread from the United Kingdom to Western Europe to the
United States then to Canada, Australia, and New Zealand. Africa, South
America, and Asia were left behind. Between 1800 and 1950, there was a
divergence between the standards of living in the richest and poorest
➔ There is essentially no correlation across countries between the level of
output per capita in 1960 and the average rate of growth in output per
capita for years 1960-2007. Standards of living across countries would be
converging if real income per capita were converging to some common
value. For this to happen, the poorest countries would have to grow at a
rate higher than that of the richest countries. If convergence in real
income per capita occurred, a negative correlation between growth rate
in real income per capita and the level of real per capita income across
countries. (For all countries, convergence is not detectable for this
➔ Richer countries are much more alike in terms of rates of growth of real
per capita income than are poor countries. Variability in real income
growth rates is much smaller for rich countries than for poor countries. The Malthusian Model of Economic Growth:
Thomas Malthus, a political economist in England, wrote the influential “An
Essay on the Principle of Population”, in which he argues that any advances in
the technology for producing food would lead to further population growth,
with the higher population ultimately reducing the average person to the
subsistence level of consumption they had before the advance in technology.
The population and level of consumption would grow over time, but in the long
run, there would be no increase in the S.O.L unless there some limits on
population growth. This theory is pessimistic about prospects for increase in
S.O.L and it states that collective intervention in the form of forced family
planning is required to bring about gains in per capita income.
Dynamic decision is one which is made for than one time period. (A static
decision is made for only one time period).
Constant returns to scale means that if factor inputs are changed by x units,
then the output changes by the same factor x.
Formalization of Malthusian Theory:
The model below formalizes Malthusian theory. The model is a dynamic one
with many periods--that is current period and future period (the period
following the current period).
Given an aggregate production function which specifies how current aggregate
output Y, is produced using current factor inputs land, L and labor, N.
That is, Y=zF(L,N),
where z is total factor productivity,
F is a function (having the properties of constant returns to scale) of land and
and think of Y as food that perishes from period to period.
In this economy there is no investment or savings (recall that in a closed
economy, investment is equal to savings).
The assumption is that there is no way to store food from one period to
another, and that there is no technology to convert food into capital. Also,
there is no government spending, land is fixed in supply--that is, all of the land
that could potentially be used for agriculture is under cultivation.
Also, the assumption that every individual in this economy is willing to work
at any wage and has one to of labor to supply. That is N form Y=zF(L,N) is both
the population and labor input. Let N be the population next period, then
N = N + Births - Deaths or N = N + N(Birth rate - death rate),
where birth rate is the ratio of births to population and the death rate is the
ratio of deaths to population.
Before the Industrial Revolution, it is natural to assume that the birth rate
would be an increasing function of C N (which is the measure of nutrition,
and C is aggregate consumption). As consumption per person rises, nutrition
improves, people have more children by choice as they are able to provide for
them, and better nutrition increases fertility.
The death rate is a decreasing function of C/N.
GO TO NOTES.
● An exogenous growth model is one in which growth is not caused by
forces determined by the model (caused by forces outside of the model).
● An endogenous growth model is one in which growth is caused by forces
determined by the model.
● Steady State is a long-run equilibrium or rest point.
● The per-worker production function describes the relationship
between output per (Y/N) and land per worker (L/N) in the Malthusian
model assuming constant returns to scale.
● The equilibrium condition per worker is c=zf(l).
● The pessimistic aspect of the Malthusian model is that improvements in
technology for producing food do not improve the standards of living in
the long-run. A better technology generates better nutrition and more
population growth, and the extra population ultimately consumes all of
the extra food produced, so that each person is no better off than before
the technological improvement.
● Society can be better off in the Malthusian world population control is
state-mandated. That is, a policy such as the one child policy in China.
This would reduce the population growth for each level of consumption
How Useful is the Malthusian Model of Economic Growth
The first economic growth fact states that before the industrial revolution in
about 1800, the standards of living differed little over time and across
countries. The Malthusian model predicts this if population growth depends on
the same way as consumption per worker across countries. Before the industrial revolution, production was mostly agricultural, and as the
population grew over time, aggregate production grew as well, but there
appears to have been no significant improvements in the average S.O.L, which
is consistent with the Malthusian model.
Malthus was ultimately wrong with regards to the ability of economies to
produce long-run improvements in the S.O.L and the effect of the S.O.L on
population growth? Why?
❖ he didn’t allow for the effect of increases in capital stock on production.
There is no limit to the size of capital stock, and having more capital
implies that there is more productive capacity to produce additional