Copyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-1CHAPTER4TheTheoryofEconomicGrowthCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-2Questions•Whataretheprincipaldeterminantsoflong-runeconomicgrowth?•Whatequilibriumconditionisusefulinanalyzinglong-rungrowth?•Howquicklydoesaneconomyheadforitssteady-stategrowthpath?Copyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-3Questions•Whateffectdoesfasterpopulationgrowthhaveonlong-rungrowth?•Whateffectdoesahighersavingsratehaveonlong-rungrowth?Copyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-4Long-RunEconomicGrowth...•isthemostimportantaspectofhowtheeconomyperforms•canbeacceleratedbygoodeconomicpolicies•canberetardedbybadeconomicpoliciesCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-5Long-RunEconomicGrowth•Policiesandinitialconditionsaffectgrowththroughtwochannels–theirimpactontheleveloftechnology•multipliestheefficiencyoflabor–theirimpactonthecapitalintensityoftheeconomy•thestockofmachines,equipment,andbuildingsthattheaverageworkerhasathisorherdisposalCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-6Technology•leadstoahigherefficiencyoflabor–skillsandeducationofthelaborforce–abilityofthelaborforcetohandlemodernmachines–theefficiencywithwhichtheeconomy’sbusinessesandmarketsfunction•Economistsaregoodatanalyzingtheconsequencesofbettertechnology–havelesstosayaboutthesourcesCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-7CapitalIntensity•Thereisadirectrelationshipbetweencapital-intensityandproductivity•Twoprincipaldeterminants–investmenteffort•theshareoftotalproductionsavedandinvestedinordertoincreasethecapitalstock–investmentrequirements•howmuchofnewinvestmentisusedtoequipnewworkerswiththestandardlevelofcapitalortoreplaceworn-outorobsoletecapitalCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-8StandardGrowthModel•AlsocalledtheSolowmodel•Steady-statebalanced-growthequilibrium–thecapitalintensityoftheeconomyisstable–theeconomy’scapitalstockandlevelofrealGDParegrowingatthesamerate–theeconomy’scapital-outputratioisconstantCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-9StandardGrowthModel•Firstcomponentistheproductionfunction–tellsushowtheproductiveresourcesoftheeconomycanbeusedtoproduceanddeterminethelevelofoutputE]F[(K/L),(Y/L)•Cobb-Douglasproductionfunction-1(E)(K/L)(Y/L)Copyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-10StandardGrowthModel•Parametersofthemodel–Eistheefficiencyoflabor•ahigherlevelofEmeansthatmoreoutputperworkercanbeproducedforeachpossiblevalueofthecapitalstockperworker–measureshowfastdiminishingmarginalreturnstoinvestmentsetin-1(E)(K/L)(Y/L)Copyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-11StandardGrowthModel•01–alevelofnearzeromeansthattheextraamountofoutputmadepossiblebyeachadditionalunitofcapitaldeclinesveryquicklyasthecapitalstockincreases-1(E)(K/L)(Y/L)Copyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-12Figure4.1-TheCobb-DouglasProductionFunctionforParameterNearZeroCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-13StandardGrowthModel•01–alevelofnearonemeansthatthenextadditionalunitofcapitalmakespossiblealmostaslargeanincreaseinoutputasthelastunitofcapital–alevelofequaltoonemeansthatchangesinoutputareproportionaltochangesincapital-1(E)(K/L)(Y/L)Copyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-14Figure4.2-TheCobb-DouglasProductionFunctionforParameterNear1Copyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-15Figure4.3-TheCobb-DouglasProductionFunctionisFlexibleCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-16StandardGrowthModel•Growthinlaborforce(L)–assumethatLisgrowingataconstantrate(n)t1tLn)(1L–ifthisyear’slaborforceisequalto10millionandthegrowthrateis2%peryear,nextyear’slaborforcewillbemillion10.2100.02)(1L1tCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-17Figure4.4-ConstantProportionalLabor-ForceGrowth(atRaten=2PercentperYear)Copyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-18StandardGrowthModel•Growthintheefficiencyoflabor(E)–assumethatEisgrowingataconstantproportionalrate(g)t1tEg)(1E–ifthisyear’sefficiencyoflaboris$10,000andthegrowthrateis1.5%peryear,nextyear’sefficiencyoflaborwillbe10,150$10,000$0.015)(1E1tCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-19Figure4.5-ConstantProportionalGrowthintheEfficiencyofLabor(atRateg=1.5PercentperYear)Copyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-20StandardGrowthModel•Savingandinvestment–assumethataconstantshareofrealGDPissavedandinvestedeachyear(s)–capitalstockdoesnotgrowbyfullamountofgrossinvestment•representsthefractionofthecapitalstockthatwearsoutorisscrappedeachyear)K(δ-)Y(sKKttt1tCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-21Figure4.6-ChangesintheCapitalStockCopyright©2002byTheMcGraw-HillCompanies,Inc.Allrightsreserved.4-22St