E CONOMIC G ROWTH

Growth = Annual Growth Rate of p c Income, GDP Growth Rates across the world 65 – 95: “spectaculat”: China (8.2 %) “very good”: East Asia (5.5 %) “decent”: South East Asia “bad”: Latin America “very bad”: Sub Saharan Africa

M ODERN E CONOMIC G ROWTH : B ASIC F EATURES Today a growth rate of 2% is no surprise! Leaders over past four centuries: 1580 – 1820: Netherlands 0.2% (real p c GDP growth), 1820 – 1890: U.K. 1.2 % (annual growth of GDP), 1890 – 1989: U. S. 2.2 % (average annual growth rate). With a 2% rate, nation’s pc GDP doubles in 35 years => shorter than a life span!

T HEORIES OF E CONOMIC G ROWTH Economic growth is the result of abstention from current consumption. Economy produces variety of products => production generates income => Income buys these commodities produced (depending on distribution of income and preferences).

C IRCULAR FLOW OF E CONOMIC A CTIVITY Firms Households Consumption Expenditure Wages, Profits, Rents outflow inflow outflow inflow investmen t savings

T WO G ROUPS OF C OMMODITIES Consumption Goods: Produced for the purpose of satisfying human needs and preferences => Households buy Capital Goods: Produced for the purpose of producing other commodities => Firms buy

S AVING - I NVESTMENT If all income is paid out to households, and if households spend their income on consumption goods, where doest the market for capital goods come from? Households save, by abstaining from current consumption, households make available pool of loanable funds that firms use to buy capital goods. Buying power is channeled from savers to investors through banks, individual loans, governments, and stock markets.

S TARTING POINT OF ALL OF THE THEORY OF E CONOMIC G ROWTH : Without the initial availability of savings, it would not be possible to invest and there would be no expansion! Macroeconomic Balance: Investment Demand = Savings Leakage

S AVING & I NVESTMENT Households’ Choice Households receive income Y, can either save or consume, i.e. Y = C + S Firms’ Choice Firms produce a set of goods worth Y, these are either investment or consumption goods, i.e. Y = C + I Households and Firms in a Closed Economy In a closed economy, the value of savings equals the value of investment Y = C + I Y = C + S => S = I

KEY DEFINITION: I NVESTMENT Investment: Change in Capital Stock I(t)= K(t) – K(t-1) Intangible vs. Tangible objects that contributes to increased production. Human Capital: Act of training and education Change in Capital Stock occurs because of : Deliberate actions of firms, i.e. Purchase of new capital goods, sale of old capital goods Depreciation, i.e. Natural wear and tear

Economic Growth is positive when investment exceeds the amount necessary to replace depreciated capital, thereby allowing the next period’s cycle to recur on a larger scale => Economy expands!

T HE H ARROD – D OMAR M ODEL -1-

T HE H ARROD – D OMAR M ODEL -2-

T HE H ARROD – D OMAR M ODEL -3- Recipe: Growth pc = (savings rate/ capital output ratio) - population growth rate - depreciation

T HE H ARROD – D OMAR M ODEL -4-