# Macro Lec 1

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 Author: vanthemi ID: 79952 Filename: Macro Lec 1 Updated: 2011-04-16 08:07:39 Tags: Model Economic growth Folders: Description: growth model Show Answers:

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1. Modern Explanation
1950s: Solow model clarifies: capital accumulation technological progress

1960s and early 70s: flourished

Until mid-1980s: dormant

Late 1980s: Endogenous growth based on – economics of ideas and technology (Romer, 1986) economics of human capital (Lucas, 1988)economics of government policy (Barro, 1990
2. Why study Growth?
• i)Enormous variation in per capita income across countries, e.g.,
• USA’s per capita income 40 (20) times higher than Ethiopia’s (Zimbabwe’s)
• ii)Rates of economic growth vary substantially across countries
• Growth miracles: (more than 5%) Hong Kong, South Korea
• Growth disasters: (negative growth) Madagascar, Venezuela
• b.Incomes are just accumulated growth rates:
• For example, let
• y(t) = per capita income at time t
• y(0) = some initial value of per capita income.
• g = average rate of growth
• t = time.
• y(t)=y(0)e^(gt)
• c. Small differences in growth make a big difference to incomes over long periods of time
• In 1900 GDP per capita:
• \$2,765 Argentina \$2,882 Austria
• Over the next 100 years average annual growth
• 1.13% Argentina 1.94% Austria
• In 2000 GDP per capita
• \$8,544 Argentina \$20,097 Austria
• d. Time to double the income: i.e., y(t*) = 2 y(0)
• y(t*)=2y(0)=y(0)e^(gt*)
• => t*= log 2/g =0.7/g
3. Cause of economic growth
4. H-D Model
• -explains an economy's growth rate in terms of the level of saving and productivity of capital
• -physical capital accumulation is the driving force of growth
• -the economy's rate of growth depends on: the level of saving and the saving ratio/ the productivity of investment i.e. Economy's capital output ratio
• It suggests there is no natural reason for an economy to have balanced growth. It suggest that more saving and productivity create growth but didn't explain how to increase saving and productivity => it makes model less effective

• Notations:
• Y = Output; K = Capital; L = Labour; S =
• Savings,
• I = Investment; m = Population growth;
• v = capital–output ratio = K/Y

• Assumptions: (all assumptions mention fixed variable => the model's problem)
• 1. Single good economy
• 2. Closed economy with no government intervention
• 3. Population growth (m) fixed
• 4. Rate of savings exogenous. i.e., the
• consumers save a fixed proportion of income.
• 5. Both K and L used to produce final goods in fixed proportions, i.e., K/L fixed.

• Capital
• 6. Economy has a fixed capital-output ratio (K/Y), i.e., K/Y fixed.

Working of the model:

5. Implications of the Harrod Domar model
• (a) Economic growth requires policies that
• Encourage saving to have more physical
• capital accumulation,
• increases productivity of capital), which lower capital-output ratio.
• (b) In order to have full employment of
• labour force, economy needs to grow at a rate equal to population growth rate.
6. Criticism
• - It is difficult to stimulate the desired level of domestic savings
• -Diminishing marginal returns to capital equipment exist; so each successive unit of investment is less productive and the capital to output ratio rises.
• -The amount of investment (physical capital accumulation) is just one factor affecting growth e.g. human capital (education and training)
• -Whether we consider (1.8) or (1.9), all four
• parameters (i.e., m,yA,s and v) are exogenous
• -Once disequilibrium (m ≠ s/v), always disequilibrium

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