Lecture 5: Working With The Model L11200 Introduction to Macroeconomics 2009/10 Reading: Barro Ch.4 : p February 2010

Introduction Where we are so far – Built a model of growth: crucially, output growth determined by growth in capital per worker – Showed what determines growth of capital per worker This time: reinforce how the model works – Predictions for level and rates of growth in GDP – Aim: to understand what determines economic growth and explain cross-county growth rates

Where are we? Growth in GDP per worker depend on growth in capital per worker Growth in capital per worker given by So growth in GDP per worker is:

Where are we? Showed that means that: – At low levels of k output per worker grows faster – But the growth rate falls it nears k* – When it reaches k* growth in output per worker is 0 – Output is growing, but output per worker is 0 because the population is growing at the same rate as output growth.

Implications 1 Implications – Economics with low levels of GDP per capita should grow faster than economies with higher levels of GDP per capita. – For all economies, growth in GDP per capita will fall over time and eventually stop. Economies reach ‘k*’ at which GDP per capita growth = 0.

Today: changing s, δ, n or A So far we have assumed all of these are fixed. What happens if they change? E.g. – Workers decide to save more, so s increases – Workers decide to reproduce more!, so n increases – Machines wear-out faster, so δ increases – Technology (not considered so far) improves so A increases.

Predictions from Solow Model Increasing the saving rate: raises rate of growth and level of steady state k*, y* Increasing the technology level: raises rate of growth and level of steady state k*,y* Increasing population growth rate: lowers rate of growth and level of steady state k*, y*

‘Absolute’ Convergence Now can begin to use the model to address data. We will look at two predictions – ‘Absolute convergence’: if s, n, δ, A are the same across all economies, they will all converge to the same level of k*, y*. i.e. the same GDP per capita – ‘Conditional Convergence’

‘Absolute’ Convergence Absolute convergence: all economies moving towards the same GDP per capita – So counties with lower k*, y* are only the same trajectory for growth as countries with higher k*, y* – economies with lower k, y are further away from k*,y* so should grow faster. – Ccan test this empirically

Empirical Evidence So absolute convergence doesn’t appear to hold internationally: actually, higher GDP per capita economies have higher growth rates But it does appear to hold within groups of similar nations / within nations So.. maybe variation in s, n, δ, A across nations, but not within nations (or similar nations) explains the puzzle…

Summary Model predict that economies move to different levels of GDP per capita if key variables vary between economies No variation in these implies absolute convergence to a level of per capita GDP, but evidence rejects this Next time: allow these factors to vary and test ‘conditional convergence’