Lecture Notes

1
Lecture Notes

• October 28, 2003
• reminder second exam is Thursday
• link to last years second exam is on the class
  page

2
Chapter 8

• Why Do Economies Grow?

3
Reasons for Growth in Per-capita GDP

• (proximate reasons)
• capital deepening (increases in capital per
  capita)
• Technological change
• Evidence that TC is more important rapid
  recovery of Germany, Japan, Italy from World War
  II.
• Capital deepening would lead you to expect high
  growth rates, but not that the losers of WWII
  would end up doing better than the winners!

4
Capital Deepening

• (Careful a high capital stock per worker
  produces high output/worker, but not increasing
  output/worker
• An increasing capital stock/worker produces
  increasing output/worker)
• What determines whether capital deepening occurs?
• Saving vs. depreciation and population growth
• High rate of saving means capital stock per
  worker will reach a high level

5
Limits to capital deepening

• With a given saving rate, no matter how high,
  its cant continue indefinitely depreciation
  increases

6
Solow model (appendix)

• A dynamic version of the classical model
• (dynamic involves time)
• Individuals have a constant saving rate (as a
  proportion of income
• Depreciation is a constant proportion of capital
• Low capital per capita saving ( investment)
  exceeds depreciation, so that capital stock per
  worker increases

7
Solow Model

• From the aggregate production function, can graph
  output/worker as a function of capital/worker

8

• With a constant saving rate, saving/worker has
  the same shape.
• Savings are allocated between (1) replacing
  depreciated capital and (2) capital deepening
• Depreciation is proportional to capital

9
Solow model
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Steady state

• The economy converges to a point where
  depreciation fully absorbs saving.
• Capital stock per worker stops growing
• Conclusion high saving can only increase the
  growth rate temporarily (although temporarily
  may be many years)
• Japan

11
Population growth

• Plays the same role as depreciation
• New saving goes to
• replacing depreciated capital
• capital widening (equipping the new population
  with capital)
• capital deepening
• Rapid population growth results in lower
  steady-state capital.

12
Technological Progress

• Affects growth permanently (unlike an increase in
  saving)
• Closely related to quality change to the extent
  that the technology changes, the quality of
  consumer and product goods changes.
• Govt tries to allow for this in measuring real GDP

13
Tech. change as a contributor to GDP growth

• From aggregate production function, GDP growth is
  due to
• Increases in capital, labor inputs
• quality adjusted
• Shifts in the production function due to
  technological change
• (Note this breakdown is ambiguous to the extent
  that quality change in capital goods is due to
  tech. change.)

14
Growth Accounting

• They try to measure these, analyze the sources of
  real GDP growth.
• Tech. change is in effect a residual
• Most of GDP growth is due to tech. change.

15
Labor Productivity

• GDP per manhour
• Productivity slowdown
• Productivity growth slowed in 70s, 80s.
• Why?
• Now (1995 on) growth has resumed at the normal
  rate or higher!
• Computers incorporated in business?

16
Labor hoarding

• During a recession, firms decrease production.
• Are reluctant to lay off workers (very costly to
  rehire)
• So measured labor productivity drops.

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Human Capital

• A major determinant of tech. change
• Labor input is like the (physical) capital input
  in most respects
• Productivity of labor depends on expenditures on
  education
• Big increase in returns to education
• Fewer and fewer blue-collar jobs badly paid.
• Saving rate should include expenditure on
  education

18
Classical Economics

• Review classical economics prices, wages,
  etc. are flexible.
• At best, this describes what happens in the long
  run (after prices have adjusted)
• Conclusion what is the long-run effect of
  fiscal, monetary policy on real GDP?
• None. In the long-run real GDP is determined in
  the labor market.
• Fiscal, monetary policy affect inflation and the
  composition of GDP, of course.

19
Short run

• How long is the long run? Months? Years?
  Decades?
• Keynesian economists think the short run can last
  quite a long time
• Keynes In the long run we are all dead.
• So government policy should try to stabilize GDP
  over the short run
• Classical economists this is likely to do more
  harm than good

20
Keynesian economics

• We should look at a classical model, and see what
  happens when prices dont adjust.
• Too hard.
• So instead well discuss a simple Keynesian model
  in which the classical conclusions dont hold
• Wont connect it with the classical model at all.
• advantage easier
• disadvantage you dont have an easy way to
  focus on where classical, Keynesian economics
  differ

21
What is Keynesian economics?

• Price-wage rigidity?
• No sign of price rigidity in 1932,
• This couldnt be what was wrong with the
  classical model
• Insofar as Keynesian models require wage
  rigidity, they dont give good explanations for
  Great Depression
• Bottom line its not obvious that Keynesian
  economics makes any sense
• Not obvious exactly how it differs from
  classical.