Economic Growth

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Economic Growth

• Professor Chris Adam
• Australian Graduate School of Management
• University of Sydney and University of New South
  Wales

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INTRODUCTION

• Observe rising incomes and standards of living
• Know that level of GDP driven by
• Capital
• Labour
• Technology
• Changes in GDP must come from changes in factors

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REAL GROWTH
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GROWTH OF COUNTRIES
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GROWTH MODEL

• Solow-Swan growth model (1956)
• Dynamic capital accumulation
• Can explain how growth occurs
• Can explain differences in growth
• Key elements are savings and population growth
• Technological progress also important but not
  covered here

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GROWTH MODEL

• Supply of goods and production
• Y F(K, L)
• Constant returns to scale
• Analyze all quantities relative to labour force
• Y/L F(K/L, 1) or y f(k)

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GROWTH MODEL

• Supply of goods and production
• Slope of function is marginal productivity of
  capital per worker
• Slope declines with increased capital per worker

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LABOUR PRODUCTIVITY
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GROWTH MODEL

• Demand for goods and consumption
• Output per worker divided between consumption
  goods and investment goods
• y c i
• Omits government and international sectors

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GROWTH MODEL

• Demand for goods and consumption
• Savings is fraction 0 lt s lt 1 of income, so
  consumption is
• c (1 s)y
• Implies investment equals saving i sy

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USING GROWTH MODEL

• Capital stock growth and steady state
• Investment (i) increases capital stock savings
  (sf(k)) increases capital stock
• Depreciation reduces capital stock depreciation
  rate d
• Change in capital stock Dk then
• Dk i dk

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USING GROWTH MODEL

• Capital stock growth and steady state
• Steady state when Dk 0
• implying i sf(k) dk for k steady state
  (constant) capital per worker

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USING GROWTH MODEL

• How savings affects growth
• Increased savings rate (s) means less consumption
  per worker and more investment
• Leads to higher level of capital stock per worker
  (k)
• Strong empirical support

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SAVINGS
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USING GROWTH MODEL

• What determines savings rates?
• Similar investment rates do not always produce
  same income per worker what else matters?

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GOLDEN RULE OF GROWTH

• Is more savings always good?
• Gives larger capital stock per worker and higher
  output per worker
• But reduces consumption per worker
• Want to compare steady states to see which has
  highest consumption per worker

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GOLDEN RULE OF GROWTH

• Consider level of consumption at steady state
• c f(k) dk
• Consumption is what is left of steady state
  output after allowing for steady state
  depreciation
• Set level of savings to ensure c is maximized
  this is Golden Rule Savings
• occurs when marginal product of k equals d

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TRANSITION TO GOLDEN RULE

• Too much capital per worker
• Policy maker lowers saving rate to Golden Rule
  level
• Increases consumption and reduces investment
• Investment rate now below depreciation rate
• Reduces output, investment further
• Consumption decreases from peak, but will remain
  above original level since at Golden Rule

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TRANSITION TO GOLDEN RULE

• Too little capital per worker
• Policy maker increases saving rate to Golden Rule
  level
• Reduces consumption and increases investment
• Investment rate now above depreciation rate
• Increases output, investment further
• Consumption increases from dip, and will remain
  above original level since at Golden Rule

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POPULATION GROWTH

• Growth in population increases workforce
• Dilutes capital and output per worker at steady
  state
• Population growth rate (n) reduces capital stock
  per worker in same way as depreciation
• Dk i (d n)k
• sf(k) (d n)k
• Steady state k from
• Dk 0 sf(k) (d n)k

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POPULATION GROWTH

• Growth in population has three effects on growth
• Better view of sustained growth drivers total
  output grows
• Better view of national income differences
  higher population grow lowers GDP per person
• Golden Rule adjusted now marginal product of
  capital per worker to equal (d n)

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TAKEAWAYS

• Solow-Swan model shows
• How saving sets steady state capital stock per
  worker and steady state income per worker
• How population growth sets steady state capital
  stock per worker and steady state income per
  worker
• What policy makers might do to maximize
  consumption per worker in steady state