1. Slides prepared by Ed Wilson
Chapter 3
Growth and Accumulation
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

2. Slides prepared by Ed Wilson
Chapter Organisation
3.1 Growth Accounting
3.2 Empirical Estimates of Growth
3.3 Neoclassical Growth Theory
3.4 Convergence
3.5 Exogenous Technological Change
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

3. Slides prepared by Ed Wilson
3.1 Growth Accounting
Growth accounting explains:
the contribution of factors of production
to the growth in total output
The production function is
Y = AF (K, N) (3.1)
It shows the quantitative relationship between factor inputs and output
capital
labour
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

4. Slides prepared by Ed Wilson
Production Function
Y = AF (K, N) (3.1)
The production function shows that output is positively correlated with:
the marginal product of labour (MPN) defined as Y/  N
the marginal product of capital (MPK) defined as Y/  K
technology given by the parameter A
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

5. Slides prepared by Ed Wilson
Production Function
Transforming Y = AF (K, N) to measure growth rates gives equation (3.2)
Output growth
labour growth
capital growth
Labour share
Capital share
Technical progress
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

6. Slides prepared by Ed Wilson
Production Function
Transforming Y = AF (K, N) to measure growth rates gives equation (3.2)
Output growth
labour growth
capital growth
Labour share
Capital share
Technical progress
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

7. Slides prepared by Ed Wilson
Production Function
The contribution of labour and capital to output equals
their individual growth rates
multiplied by the share of that input towards output
The third term is total factor productivity (TFP), which measures the rate of technical progress
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

8. Slides prepared by Ed Wilson
Production Function
Subtracting population growth N/N from both sides gives
(3.4)
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

9. Slides prepared by Ed Wilson
Production Function
(3.4)
The parameter  usually has a value of 0.25 for Australia
For the period 1950–92 in Australia
the average annual growth rate of per capita capital was 4.3% pa
the average annual growth rate of per capita output was 2.0% pa
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

10. Slides prepared by Ed Wilson
Production Function
Equation 3.4 shows that
per capita capital growth of 4.3% pa contributed 0.25  4.3% = 1.075% pa to per capita output growth
the recorded per capita output growth was 2.0% pa.
The remaining per capita output growth of = 0.925% pa was mostly due to technological progress
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

11. Slides prepared by Ed Wilson
Production Function
The comparable figures for Japan are
per capita capital growth of 7.1% pa contributed 0.25  7.1% = 1.775% pa to per capita output growth
The recorded per capita output growth was 5.7% pa
technological progress was responsible for = 3.925% pa of the per capita output growth
Which country is performing better?
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

12. Slides prepared by Ed Wilson
Production Function
Compare these per capita growth rates (%)
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

13. Slides prepared by Ed Wilson
Chapter Organisation
3.1 Growth Accounting
3.2 Empirical Estimates of Growth
3.3 Neoclassical Growth Theory
3.4 Convergence
3.5 Exogenous Technological Change
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

14. 3.2 Empirical Estimates of Growth
The simple production function
Y = AF (K, N) (3.1)
Ignores important factor inputs which also affect economic growth
Other possible factor inputs are
natural resources
public infrastructure capital
human capital
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

15. Empirical Growth Estimates
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

16. Empirical Growth Estimates
History has shown the two most important factors that increase GDP are
capital accumulation (physical and human)
technical progress
Incorporating human capital (H) into the production function gives
Y = AF (K, H, N) (3.5)
Important to distinguish labour endowment (N) from acquired human capital skills (H)
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

17. Slides prepared by Ed Wilson
Chapter Organisation
3.1 Growth Accounting
3.2 Empirical Estimates of Growth
3.3 Neoclassical Growth Theory
3.4 Convergence
3.5 Exogenous Technological Change
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

18. 3.3 Growth Theory: The Neoclassical Model
Growth theory attempts to explain
how economic decisions affect the accumulation of the factors of production
why some nations such as the US and Japan have grown rapidly over the last 150 years
while other nations such as Bangladesh have experienced virtually zero growth
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

19. Neoclassical Growth Theory
Initially, neoclassical growth theory assumes there is no technical progress
This implies that the economy will reach a steady-state equilibrium
where per capita GDP and per capita capital remain constant
per capita capital cannot grow endlessly because of diminishing marginal product of capital
the economy, therefore, reaches a steady-state equilibrium
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

20. Neoclassical Growth Theory
In a steady state the level of investment required to maintain per capita capital depends on
population growth (n =  N/N)
the depreciation rate (d)
The economy needs investment to maintain the level of per capita capital
nk to provide capital for new workers
dk to replace existing capital
total investment requirement is (n + d)k
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

21. Neoclassical Growth Theory
Assume
constant population growth (n) and depreciation (d)
a closed economy
there is no government sector
savings are a constant fraction (s) of income (s is APS)
total per capita savings are therefore sy = sf (k)
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

22. Neoclassical Growth Theory
These assumptions give
steady-state equilibrium (y* and k*)
where per capita savings equals investment
sy* = sf (k*) = (n + d)k*
This relationship is represented in Figure 3.4
the saving relationship sf (k*) is the (concave to the k axis) production function
the investment relationship (n + d)k* is the straight ray from the origin
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

23. Neoclassical Growth Theory
Consider Figure 3.4
When saving exceeds investment required
sf (k0) > (n + d)k0
per capita capital increases from k0 to k*
Beyond point C
diminishing MPK ensures savings are less than the required investment
sf (k0) < (n + d)k0
per capita capital decreases to k*
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

24. Neoclassical Growth Theory
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

25. Neoclassical Growth Theory
Hence, the economy reaches a steady state at point C
This implies that steady-state growth rate is not affected by the level of savings
In the long run an increase in the rate of savings
raises the long-run level of capital and output per capita
but not the growth rate of output
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

26. Slides prepared by Ed Wilson
Chapter Organisation
3.1 Growth Accounting
3.2 Empirical Estimates of Growth
3.3 Neoclassical Growth Theory
3.4 Convergence
3.5 Exogenous Technological Change
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

27. Slides prepared by Ed Wilson
3.4 Convergence
Neoclassical growth theory predicts absolute convergence for economies with
equal rates of savings and population growth
access to the same technology
This model predicts conditional convergence for economies that differ in
rates of savings,
human capital development
or population growth
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

28. Slides prepared by Ed Wilson
Convergence
Conditional convergence means
steady-state per capita incomes differ
while per capita incomes growth rates equalise
Empirical evidence suggests that some nations have shown
divergence with poor countries growing slower than rich nations
absolute convergence for some nations with common characteristics
conditional convergence characteristics
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

29. Slides prepared by Ed Wilson
Chapter Organisation
3.1 Growth Accounting
3.2 Empirical Estimates of Growth
3.3 Neoclassical Growth Theory
3.4 Convergence
3.5 Exogenous Technological Change
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

30. 3.5 Exogenous Technological Change
The comparison of Australia and Japan shows the importance of technology
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

31. Slides prepared by Ed Wilson
Technological Change
We, therefore, allow technology to exogenously increase in the model
That is A/A > 0
The function Y = AF (K, N) shows the technology effect as total factor productivity (TFP)
An alternative is labour-augmenting technology Y = F (K, AN)
We will stay with (TFP)
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

32. Slides prepared by Ed Wilson
Technological Change
The effect of exogenous increases in TFP on the neoclassical model is similar to an increase in savings
The new steady-state point is at an increasing per capita output and capital-labour ratio
However, the growth rate of per-capita output remains constant
It grows at the same constant TFP rate
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson

33. Slides prepared by Ed Wilson
Technological Change
The neoclassical growth model is an important reference
However the model’s assumptions and validity have been questioned
Endogenous growth theory has been developed to allow for more complicated and realistic endogenous increases in TFP
Copyright  2002 McGraw-Hill Australia Pty Ltd PPTs t/a Macroeconomics by Dornbusch, Bodman, Crosby, Fischer and Startz
Slides prepared by Ed Wilson