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Macro economics

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Macroeconomics ECO 403
VU
LESSON 19
ECONOMIC GROWTH
Issues in Economic Growth
·  Learn the closed economy Solow model
·  See how a country's standard of living depends on its saving and population growth
rates
·  Learn how to use the "Golden Rule"
to find the optimal savings rate and capital stock
Per Capita Income of Selected Countries, 2004 (in US $)
Norway
43,350
Saudi Arabia
8,530
Switzerland
39,880
Mexico
6,230
United States
37,610
Malaysia
3,780
Japan
34,510
Brazil
2,710
United Kingdom
28,350
Russia
2,610
Belgium
25,820
Egypt
1,390
Germany
25,250
China
1,100
France
24,770
Indonesia
810
Australia
21,650
India
530
Italy
21,560
Pakistan
470
Kuwait
16,340
Bangladesh
400
Korea
12,020
Nigeria
320
THE SOLOW MODEL
·  Due to Robert Solow, won Nobel Prize for contributions to the study of economic
growth
·  A major paradigm:
­  Widely used in policy making
­  Benchmark against which most
recent growth theories are compared
·  Looks at the determinants of economic growth and the standard of living in the long run
·  The Solow Growth Model is designed to show how growth in the capital stock, growth
in the labor force, and advances in technology interact in an economy, and how they
affect a nation's total output of goods and services.
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Macroeconomics ECO 403
VU
How Solow model is different
1.
K is no longer fixed: investment causes it to grow, depreciation causes it to shrink.
2.
L is no longer fixed: population growth causes it to grow.
3.
The consumption function is simpler.
4.
No G or T (only to simplify presentation; we can still do fiscal policy experiments)
5.
Cosmetic differences.
The production function
Let's analyze the supply and demand for goods, and see how much output is produced at any
given time and how this output is allocated among alternative uses.
The production function represents the transformation of inputs (labor (L), capital (K),
and production technology) into outputs (final goods and services for a certain time period).
·  In aggregate terms: Y = F (K, L )
·  Define: y = Y/L = output per worker
k = K/L = capital per worker
·  Assume constant returns to scale:
zY = F (zK, zL ) for any z > 0
·  Pick z = 1/L. Then
Y/L = F (K/L , 1)
y = F (k, 1)
y =  f(k) where f(k)
= F (k, 1)
Output per
worker, y
f(k)
MPK =f(k +1) ­ f(k)
1
Note: this production
function exhibits
diminishing MPK.
Capital per
worker, k
The national income identity
·  Y=C+I
(remember, no G )
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Macroeconomics ECO 403
VU
In "per worker" terms:
·
y=c+i
where c = C/L and i = I/L
The consumption function
·  s = the saving rate, the fraction of income that is saved (s is an exogenous parameter)
·  Note: s is the only lowercase variable that is not equal to its uppercase version
divided by L
·  Consumption function: c = (1­s)y (per worker)
Saving and investment
·  saving (per worker)  = sy
·  National income identity is y = c + i
Rearrange to get: i = y ­ c = sy
(investment = saving)
·  Using the results above,
i = sy = sf(k)
Output, consumption, and investment
Output per
f(k)
worker, y
c1
sf(k)
y1
i1
Capital per
k1
worker, k
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Macroeconomics ECO 403
VU
Depreciation
Depreciation per
δ = the rate of depreciation
worker, δk
= the fraction of the capital stock that
wears out each period
δk
δ
1
Capital per
worker, k
Capital accumulation
The basic idea:
Investment makes the capital stock bigger, depreciation makes it smaller.
Change in capital stock= investment ­ depreciation
Δk  =
δk
i
­
Since i = sf (k), this becomes:
Δk = s f(k) ­ δk
The equation of motion for k
Δk = s f(k) ­ δk
·  the Solow model's central equation
·  Determines behavior of capital over time which, in turn, determines behavior of all of
the other endogenous variables
because they all depend on k. e.g., income per person:
y = f(k)
Consumption .per person:
c = (1­s) f(k)
The steady state
If investment is just enough to cover depreciation
[sf(k) = δk ],
then capital per worker will remain constant:
Δk = 0.
This constant value, denoted k*, is called the steady state capital stock.
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Macroeconomics ECO 403
VU
Investment and
depreciation
δk
sf(k)
k*
Capital per
worker, k
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Table of Contents:
  1. INTRODUCTION:COURSE DESCRIPTION, TEN PRINCIPLES OF ECONOMICS
  2. PRINCIPLE OF MACROECONOMICS:People Face Tradeoffs
  3. IMPORTANCE OF MACROECONOMICS:Interest rates and rental payments
  4. THE DATA OF MACROECONOMICS:Rules for computing GDP
  5. THE DATA OF MACROECONOMICS (Continued…):Components of Expenditures
  6. THE DATA OF MACROECONOMICS (Continued…):How to construct the CPI
  7. NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES
  8. NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)
  9. NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)
  10. NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)
  11. MONEY AND INFLATION:The Quantity Equation, Inflation and interest rates
  12. MONEY AND INFLATION (Continued…):Money demand and the nominal interest rate
  13. MONEY AND INFLATION (Continued…):Costs of expected inflation:
  14. MONEY AND INFLATION (Continued…):The Classical Dichotomy
  15. OPEN ECONOMY:Three experiments, The nominal exchange rate
  16. OPEN ECONOMY (Continued…):The Determinants of the Nominal Exchange Rate
  17. OPEN ECONOMY (Continued…):A first model of the natural rate
  18. ISSUES IN UNEMPLOYMENT:Public Policy and Job Search
  19. ECONOMIC GROWTH:THE SOLOW MODEL, Saving and investment
  20. ECONOMIC GROWTH (Continued…):The Steady State
  21. ECONOMIC GROWTH (Continued…):The Golden Rule Capital Stock
  22. ECONOMIC GROWTH (Continued…):The Golden Rule, Policies to promote growth
  23. ECONOMIC GROWTH (Continued…):Possible problems with industrial policy
  24. AGGREGATE DEMAND AND AGGREGATE SUPPLY:When prices are sticky
  25. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…):
  26. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…):
  27. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…)
  28. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…)
  29. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…)
  30. AGGREGATE DEMAND IN THE OPEN ECONOMY:Lessons about fiscal policy
  31. AGGREGATE DEMAND IN THE OPEN ECONOMY(Continued…):Fixed exchange rates
  32. AGGREGATE DEMAND IN THE OPEN ECONOMY (Continued…):Why income might not rise
  33. AGGREGATE SUPPLY:The sticky-price model
  34. AGGREGATE SUPPLY (Continued…):Deriving the Phillips Curve from SRAS
  35. GOVERNMENT DEBT:Permanent Debt, Floating Debt, Unfunded Debts
  36. GOVERNMENT DEBT (Continued…):Starting with too little capital,
  37. CONSUMPTION:Secular Stagnation and Simon Kuznets
  38. CONSUMPTION (Continued…):Consumer Preferences, Constraints on Borrowings
  39. CONSUMPTION (Continued…):The Life-cycle Consumption Function
  40. INVESTMENT:The Rental Price of Capital, The Cost of Capital
  41. INVESTMENT (Continued…):The Determinants of Investment
  42. INVESTMENT (Continued…):Financing Constraints, Residential Investment
  43. INVESTMENT (Continued…):Inventories and the Real Interest Rate
  44. MONEY:Money Supply, Fractional Reserve Banking,
  45. MONEY (Continued…):Three Instruments of Money Supply, Money Demand