3.1 introduction
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3.1 Introduction. In this chapter, we learn: Some facts related to economic growth that later chapters will seek to explain. How economic growth has dramatically improved welfare around the world. this growth is actually a relatively recent phenomenon. 3.1 Introduction. - PowerPoint PPT PresentationTRANSCRIPT
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3.1 Introduction• In this chapter, we learn:
– Some facts related to economic growth that later chapters will seek to explain.
– How economic growth has dramatically improved welfare around the world.
• this growth is actually a relatively recent phenomenon
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3.1 Introduction• In this chapter, we learn:
– Some tools used to study economic growth, including how to calculate growth rates.
– Why a “ratio scale” makes plots of per capita GDP easier to understand.
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• The United States of a century ago could be mistaken for Kenya or Bangladesh today.
• Some countries have seen rapid economic growth and improvements to health quality, but many others have not.
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3.2 Growth over the Very Long Run
• Sustained increases in standards of living are a recent phenomenon.
• Sustained economic growth emerges in different places at different times. – Thus, per capita GDP differs remarkably
around the world.
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• The Great Divergence– The recent era of increased difference in
standards of living across countries. • Before 1700
– Per capita GPD in nations differed only by a factor of two or three.
• Today– Per capita GPD differs by a factor of 50 for
several countries.
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3.3 Modern Economic Growth
• Timeline: from 1870 to 2000, United States per capita GDP . . .– . . . rose by nearly 15-fold.
• Implications for you?– A typical college student today will earn a
lifetime income about twice his or her parents.
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3.4 Modern Growth around the World
• After World War II, growth in Germany and Japan accelerated.
• Convergence– Poorer countries will grow faster to “catch
up” to the level of income in richer countries.
• Brazil had accelerated growth until 1980 and then stagnated.– China and India have had the reverse
pattern.
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A Broad Sample of Countries
• Over the period 1960–2007– Some countries have exhibited a negative
growth rate.– Other countries have sustained nearly 6
percent growth.– Most countries have sustained about 2
percent growth.• Small differences in growth rates result in
large differences in standards of living.
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Case Study: People versus Countries
• Since 1960:– The bulk of the world’s population is
substantially richer. – The fraction of people living in poverty has
fallen.• A major reason for changes
– Economic growth in China and India– These are 40 percent of the world
population!
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Case Study: Growth Rules in a Famous Example, Yt = AtKt
1/3Lt2/3
• Applying rules of growth rates• Original output equation:
• Use multiplication rule to get
• Use exponent rule to get
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3.6 The Costs of Economic Growth
• The benefits of economic growth– Improvements in health– Higher incomes– Increase in the variety of goods and services
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• Costs of economic growth include:– Environmental problems– Income inequality across and within
countries– Loss of certain types of jobs
• Economists generally have a consensus that the benefits of economic growth outweigh the costs.
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3.7 A Long-Run Roadmap
• Are there certain policies that will allow a country to grow faster?
• If not, what about a country’s “nature” makes it grow at a slower rate?
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Summary• Sustained growth in standards of living
is a very recent phenomenon.
• If the 130,000 years of human history were warped and collapsed into a single year, modern economic growth would have begun only at sunrise on the last day of the year.
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Summary• Modern economic growth has taken hold in
different places at different times.
• Since several hundred years ago, when standards of living across countries varied by no more than a factor of 2 or 3, there has been a “Great Divergence.”
• Standards of living across countries today vary by more than a factor of 60.
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• Since 1870– Growth in per capita GDP has averaged about
2 percent per year in the United States.– Per capita GDP has risen from about $2,500
to more than $37,000.
• Growth rates throughout the world since 1960 show substantial variation– Negative growth in many poor countries– Rates as high as 6 percent per year in several
newly industrializing countries, most of which are in Asia
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• Growth rates typically change over time
• In Germany and Japan– Growth picked up considerably after World
War II.– Incomes converged to levels in the United
Kingdom.– Growth rates have slowed down as this
convergence occurred.
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• Brazil exhibited rapid growth in the 1950s and 1960s and slow growth in the 1980s and 1990s.
• China showed the opposite pattern.
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• Economic growth, especially in India and China, has dramatically reduced poverty in the world.
• In 1960– Two out of three people in the world lived on
less than $5 per day (in today’s prices).
• By 2000– This number had fallen to only 1 in 10.
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4.1 Introduction• In this chapter, we learn:
– How to set up and solve a macroeconomic model. – How a production function can help us understand
differences in per capita GDP across countries.– The relative importance of capital per person
versus total factor productivity in accounting for these differences.
– The relevance of “returns to scale” and “diminishing marginal products.”
– How to look at economic data through the lens of a macroeconomic model.
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• A model:– Is a mathematical representation of a
hypothetical world that we use to study economic phenomena.
– Consists of equations and unknowns with real world interpretations.
• Macroeconomists:– Document facts.– Build a model to understand the facts.– Examine the model to see how effective it is.
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4.2 A Model of Production
• Vast oversimplifications of the real world in a model can still allow it to provide important insights.
• Consider the following model– Single, closed economy– One consumption good
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Setting Up the Model
• A certain number of inputs are used in the production of the good
• Inputs– Labor (L)– Capital (K)
• Production function– Shows how much output (Y) can be
produced given any number of inputs
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• Others variables with a bar are parameters.
• Production function:
Productivity parameterOutput Inputs
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• The Cobb-Douglas production function is the particular production function that takes the form of
Assumed to be 1/3.Explained later.
• A production function exhibits constant returns to scale if doubling each input exactly doubles output.
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Returns to Scale ComparisonFind the sum of
exponents on the inputs
• sum to 1
• sum to more than 1
• sum to less than 1
Result
• the function has constant returns to scale
• the function has increasing returns to scale
• the function has decreasing returns to scale
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• Standard replication argument
– A firm can build an identical factory, hire identical workers, double production stocks, and can exactly double production.
– Implies constant returns to scale.
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Allocating Resources
• The rental rate and wage rate are taken as given under perfect competition.
• For simplicity, the price of the output is normalized to one.
Firm chooses inputs to maximize profit
Rental rate of capital
Wage rate
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• The marginal product of labor (MPL)– The additional output that is produced when
one unit of labor is added, holding all other inputs constant.
• The marginal product of capital (MPK)– The additional output that is produced when
one unit of capital is added, holding all other inputs constant.
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• The solution is to use the following hiring rules:
– Hire capital until the MPK = r
– Hire labor until MPL = w
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• If the production function has constant returns to scale in capital and labor, it will exhibit decreasing returns to scale in capital alone.
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Solving the Model: General Equilibrium
• The model has five endogenous variables: – Output (Y)– the amount of capital (K)– the amount of labor (L)– the wage (w)– the rental price of capital (r)
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• The model has five equations:– The production function– The rule for hiring capital– The rule for hiring labor– Supply equals the demand for capital– Supply equals the demand for labor
• The parameters in the model:– The productivity parameter– The exogenous supplies of capital and labor
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• A solution to the model– A new set of equations that express the five
unknowns in terms of the parameters and exogenous variables
– Called an equilibrium
• General equilibrium– Solution to the model when more than a
single market clears
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• In this model
– The solution implies firms employ all the supplied capital and labor in the economy.
– The production function is evaluated with the given supply of inputs.
– The wage rate is the MPL evaluated at the equilibrium values of Y, K, and L.
– The rental rate is the MPK evaluated at the equilibrium values of Y, K, and L.
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Interpreting the Solution
• If an economy is endowed with more machines or people, it will produce more.
• The equilibrium wage is proportional to output per worker.
• Output per worker = (Y/L)• The equilibrium rental rate is
proportional to output per capital.• Output per capital = (Y/K)
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• In the United States, empirical evidence shows:– Two-thirds of production is paid to labor. – One-third of production is paid to capital.– The factor shares of the payments are equal
to the exponents on the inputs in the Cobb-Douglas function.
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• All income is paid to capital or labor.
– Results in zero profit in the economy– This verifies the assumption of perfect
competition.– Also verifies that production equals spending
equals income.
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Case Study: What Is the Stock Market?
• Economic profit– Total payments from total revenues
• Accounting profit– Total revenues minus payments to all
inputs other than capital.• The stock market value of a firm
– Total value of its future and current accounting profits
– The stock market as a whole is the value of the economy’s capital stock.
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4.3 Analyzing the Production Model
• Per capita = per person• Per worker = per member of the labor
force.– In this model, the two are equal.
• We can perform a change of variables to define output per capita (y) and capital per person (k).
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• Output per person equals the productivity parameter times capital per person raised to the one-third power.
Output per person
Capital per person
Productivity parameter
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• What makes a country rich or poor?
• Output per person is higher if the productivity parameter is higher or if the amount of capital per person is higher.
– What can you infer about the value of the productivity parameter or the amount of capital in poor countries?
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Comparing Models with Data
• The model is a simplification of reality, so we must verify whether it models the data correctly.
• The best models:– Are insightful about how the world works– Predict accurately
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The Empirical Fit of the Production Model
• Development accounting:– The use of a model to explain differences
in incomes across countries.
Set productivity parameter = 1
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• Diminishing returns to capital implies that:– Countries with low K will have a high MPK– Countries with a lot of K will have a low MPK,
and cannot raise GDP per capita by much through more capital accumulation
• If the productivity parameter is 1, the model overpredicts GDP per capita.
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Case Study: Why Doesn’t Capital Flow from Rich to Poor Countries?
• If MPK is higher in poor countries with low K, why doesn’t capital flow to those countries?– Short Answer: Simple production model
with no difference in productivity across countries is misguided.
– We must also consider the productivity parameter.
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Productivity Differences: Improving the Fit of the Model
• The productivity parameter measures how efficiently countries are using their factor inputs.
• Often called total factor productivity (TFP)
• If TFP is no longer equal to 1, we can obtain a better fit of the model.
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• However, data on TFP is not collected.
– It can be calculated because we have data on output and capital per person.
– TFP is referred to as the “residual.”
• A lower level of TFP
– Implies that workers produce less output for any given level of capital per person
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4.4 Understanding TFP Differences
• Why are some countries more efficient at using capital and labor?
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Human Capital
• Human capital– Stock of skills that individuals accumulate
to make them more productive– Education, training, etc.
• Returns to education– Value of the increase in wages from
additional schooling• Accounting for human capital reduces
the residual from a factor of 11 to a factor of 6.
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Technology
• Richer countries may use more modern and efficient technologies than poor countries.
– Increases productivity parameter
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Institutions
• Even if human capital and technologies are better in rich countries, why do they have these advantages?
• Institutions are in place to foster human capital and technological growth.– Property rights– The rule of law– Government systems– Contract enforcement
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Misallocation
• Misallocation
– Resources not being put to their best use
• Examples
– Inefficiency of state-run resources– Political interference
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Case Study: A “Big Bang” or Gradualism? Economic Reforms in
Russia and China
• When transitioning from a planned to a market economy, the change can be sudden or gradual.– A “big bang” approach is one where all old
institutions are replaced quickly by democracy and markets.
– A “gradual” approach is one where the transition to a market economy occurs slowly over time.
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• Russia followed a “big bang” approach, yet GDP per capita has declined since the transition.
• China has seen accelerated economic growth using the “gradual” approach.
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4.5 Evaluating the Production Model
• Per capita GDP is higher if capital per person is higher and if factors are used more efficiently.
• Constant returns to scale imply that output per person can be written as a function of capital per person.
• Capital per person is subject to strong diminishing returns because the exponent is much less than one.
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• Weaknesses of the model:
– In the absence of TFP, the production model incorrectly predicts differences in income.
–The model does not provide an answer as to why countries have different TFP levels.
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Summary• Per capita GDP varies by a factor of 50 between
the richest and poorest countries of the world.• The key equation in our production model is the
Cobb-Douglas production function:
Productivity parameterOutput Inputs
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• The exponents in this production function:
– One-third of GDP is paid out to capital.
– Two-thirds is paid to labor.
– Exponents sum to 1, implying constant returns to scale in capital and labor.
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• The complete production model consists of five equations and five unknowns:
- Output Y- Capital K- Labor L- Wage rate w- Rental rate r
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• The solution to this model is called an equilibrium.
• The prices w and r are determined by the clearing of labor and capital markets.
• The quantities of K and L are determined by the exogenous factor supplies.
• Y is determined by the production function.
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• The production model implies that output per person in equilibrium is the product of two key forces:
– Total factor productivity (TFP)– Capital per person
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• Assuming the TFP is the same across countries, the model predicts that income differences should be substantially smaller than we observe.
• Capital per person actually varies enormously across countries, but the sharp diminishing returns to capital per person in the production model overwhelm these differences.
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• Making the production model fit the data requires large differences in TFP across countries.
• Economists also refer to TFP as the residual, or a measure of our ignorance.
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• Understanding why TFP differs so much across countries is an important question at the frontier of current economic research.
• Differences in human capital (such as education) are one reason, as are differences in technologies.
• These differences in turn can be partly explained by a lack of institutions and property rights in poorer countries.
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Macroeconomics
This concludes the LectureSlide Set for Chapter 4
byCharles I. Jones
Second Edition
W. W. Norton & CompanyIndependent Publishers Since 1923