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Chapter

ECONOMIC GROWTH

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Department
Economics
Course
ECON 325
Professor
Sadik Arouba
Semester
Fall

Description
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 versa). ➔ 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 S.O.L. 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 models. 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 are: ➔ 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 1800. ➔ 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 growth rate. ➔ 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 countries. ➔ 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 period). ➔ 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. RECALL: 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 capital, 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. KEY POINTS: ● 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 per worker. 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 capit
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