1. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 1 Econ 210D Intermediate Macroeconomics Spring 2015 Professor Kevin D. Hoover Topic 4 Long-term Economic Growth

2. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 2 Illustrative Growth Questions Why does GDP rise over time? Why is GDP and GDP per capita higher in some countries than others How is GDP affected by increases in population from immigration or from population growth? How are GDP and labor related: how much does unemployment fall in the slump?

3. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 3 Aggregate Supply and Demand Y = C + I + G + NX Production = Expenditure Aggregate Supply = Aggregate Demand

4. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 4

5. 5 Production Function – 1 y = f(k, l) o y = output o k = capital service input o l = labor service input

6. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 6 The Production Function – 2

7. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 7 Properties of Production Functions – 1 the production function : y = f ( k, l ) no free lunch : y = f (0, l ) = 0; y = f ( k, 0) = 0 effort pays : dy/dk = f k ( k, l ) > 0; dy/dl = f l ( k, l ) > 0

8. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 8 Properties of Production Functions – 2 diminishing returns to a factor of production : o d 2 y / dk 2 = f kk ( k, l ) < 0 o d 2 y / dl 2 = f ll ( k, l ) < 0 an increase in one factor raises the productivity of the other : d 2 y / dkdl = f kl ( k, l ) > 0;

9. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 9 Choosing the Technological Mix Profits = Revenue – Cost Add labor until marginal unit (  l ) leads to more costs ( w  l ) than revenues ( p  y) Add capital until marginal unit (  k ) leads to more costs ( k ) than revenues ( p  y) Profit maximization: Marginal Cost = Marginal Revenue

10. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 10 Rules of Profit Maximization Add labor until: o marginal product of labor (mpl) = real wage o mpl =  y/  l = w/p Add capital until: o marginal product of capital (mpk) = (implicit) real rental rate o mpk =  y/  k = /p

11. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 11

12. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 12 Aggregate Production Function Y = F ( L, K ) Cobb-Douglas Production Function: Y = AL  K 1- 

13. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 13 Creators of the Cobb-Douglas Production Function Paul H. Douglas (1892- 1976) o labor economist o later U.S. Senator from Illinois Charles W. Cobb o mathematician, Amherst College Created production function in 1928

14. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 14 Properties of the Cobb-Douglas Production Function Y = AL  K 1-  mpL =  mpK = (1-  Diminishing returns to capital and labor Constant returns to scale Labor share in GDP =  Capital share in GDP = 1– 

15. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 15 Why is the Cobb-Douglas a Good Production Function? – 1

16. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 16

17. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 17 U.S. Aggregate Production Function, 2008

18. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 18 Concepts of Productivity Labor productivity :  = Y/L Capital productivity :  = Y/K Total-factor productivity:

19. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 19 Short-run Production Function - Labor

20. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 20 Short-run Production Function - Capital

21. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 21 Measures of Capacity - Labor LF = labor force EMP = employment rate = L / LF U = unemployment rate =

22. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 22 Measures of Capacity - Capital CU = capacity utilization rate =

23. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 23 Potential Output potential output scaled output

24. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 24

25. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 25 Growth Over Time U.S. GNP per capita: o 1790: $500 o 2000: $40,000 o Increase: 80 times Chad GDP per capita, 2000: $500

26. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 26 The Power of Growth Rates $1 at 1.5%/year for 2000 years = $8.5 billion o < less than U.S. GDP $1 at 2.0%/year for 2000 years = $158,614 trillion o 2,638 times world GDP 2.91%/year = best U.S. 30-year average growth (1940-1970): 1790-1990 at that rate = $171,600 per capita o 6 times actual U.S. per capita income 1990

27. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 27 Divergence of Growth Experience

28. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 28 Production Functions: 1948 & 1998 1948: Y = AL  K 1-  = 4.60 L 0.69 K 0.31 2008: Y = AL  K 1-  = 9.63 L 0.69 K 0.31

29. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 29 Production Functions: Counterfactual Interpretation – 1

30. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 30 Production Functions: Counterfactual Interpretation – 2

31. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 31 Thought Experiment – 1 What would GDP be in 1948 if ceteris paribus 1998 labor were available:

32. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 32 Thought Experiment – 2 What would GDP be in 1948 if ceteris paribus 2008 capital were available: homework problem

33. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 33 Thought Experiment – 3 What would GDP be in 1948 if ceteris paribus 1998 labor were available: o difference = $13,312 – $6.360 = $6,952 bil. (effect of  A )

34. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 34 Algebra of Growth Rates if z = xy  if z = x/y  if z = xy  if z = x 1/y  or if 

35. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 35 Growth Accounting – 1 Y = AL  K 1- 

36. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 36 Growth Accounting – 2 Percentage of Growth Attributable to: Labor: Capital: Total Factor Productivity:

37. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 37 Sources of U.S. Growth

38. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 38 The Growth Process: Rising Total Factor Productivity Product Innovation Process Innovation Research and Development

39. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 39 Product Innovation – 1

40. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 40 Product Innovation – 2

41. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 41 Product Innovation – 3: recorded music

42. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 42 Product Innovation – 4: recorded music

43. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 43 Product Innovation – 4: recorded music ?

44. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 44 Process Innovation - 1

45. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 45 Process Innovation - 2

46. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 46 Research and Development -1

47. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 47 Research and Development -2

48. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 48 Research and Development -3

49. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 49 The Growth Process: Labor Law of motion for labor: L t = (1 + n ) L t -1 Solution: L t = L 0 (1 + n ) t o n = growth rate of labor

50. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 50 The Growth Process: Capital – 1 Law of motion: K t = K t- 1 + I t -1 – depreciation t- 1 o I t = gross investment o I t – depreciation t = net investment  K t = K t – K t- 1 = I t -1 – depreciation t- 1 = net investment t- 1

51. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 51 The Growth Process: Capital – 2  K t = net investment t- 1

52. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 52 Balanced and Unbalanced Growth capital widening = more workers with same K / L capital deepening = more capital per worker ( K / L  ) balanced growth = all inputs and outputs grow at same rate – i.e., capital widening, no capital deepening unbalanced growth = inputs and output grow at different rates – capital widening and deepening

53. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 53 Balanced Growth

54. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 54 Unbalanced Growth

55. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 55 Technical Progress Recall: labor-augmenting technical progress = as if more workers ( ) capital-augmenting technical progress = as if more capital ( )

56. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 56 Balanced Growth with Technical Progress Replace with Balanced growth condition with technical progress: =

57. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 57 Balanced Growth for the U.S. and Therefore, = = speed limit for the economy

58. Professor K.D. Hoover, Econ 210D Topic4 Spring 2015 58 END of Topic 4 Next Topic: 5. Labor and Unemployment