Chapter 4 (Combining Solow and Romer) Flashcards
What is the key to long run economic growth?
Non-rivalry of ideas
Transition dynamics
if an economy starts out below its balanced growth path, it will grow rapidly in order to catch up to this path; if an economy begins above its balanced growth path, it will grow slowly for a period of time.
In the short run, counties grow at different rates. In the long run, countries grow at the same rate.
Assume that there is a balanced growth path in the long run, as all endogenous variables are growing at a constant rate
What are the 5 unknowns in the combined model?
- Output, Yt
- Capital, Kt
- Knowledge, At
- Workers in the output sector, Lyt
- Workers in the research sector, Lat
What are the 5 equations?
What is the growth rate of the production function?
- The growth rate of capital is equal to the growth rate of ouput because Yt/Kt must be constant so they grow at the same rate
Why is the growth rate of capital determine the growth rate of output?
Fraction of output over capital is constant along a balanced growth path, therefore the growth rate of capital follows the growth rate of output
Why is output higher?
Ideas have direct and indirect effect
Increasing productivity raises output because productivity has increased
Higher productivity results in a higher capital stock
Charter cities
Drawing inspiration from the historical experience of Hong Kong, Professor Romer suggests that new cities be established. In these charter cities, advanced economies would agree to set the rules by which the new city is administered. People from throughout the world would then be free to live and work in the new city. Such cities could even be established in developing countries with a charter that grants administrative rights to one or more advanced economies.
E.g. Hong Kong
Monopolisitc competiton, according to Romer
That is, if increasing returns are the key to growth, why wouldn’t the economy come to be dominated by a single, very large firm? After all, such a firm would enjoy the best advantage of increasing returns. Romer’s answer was to incorporate the modern theory of monopolistic competition into his idea model. In this theory, the economy contains many monopolists, each producing a slightly different good. They compete with each other to sell us different varieties of music, books, computers, and airplanes. Their size, as Adam Smith said, is limited by the extent of the market as well as by competition with each other.
Why is growth even higher in the combined model?
Ideas have direct and indirect effects
Increasing productivity raises output because productivity has increased
Higher productivity results in a higher capital stock
Capital output ratio
saving rate/ growth rate of output + depreciation
Shows investment rate along a balanced growth path
gk*=gy*
What does * mean?
Variables are evaluated along a growth path
What is the proof for capital output ratio
Intergrating the capital output ratio into the production function
Proof for the combined Solow-Romer production function
Raising the investment rate in the production function (change in parametr)
Raises output per person in parameter
Increase in growth path until the new growth path is reached
Since the economy is now below its new balanced growth path, the principle of transition dynamics says that the economy will grow rapidly. Notice that yt is plotted on a ratio scale, so the slope of the path is the growth rate.
output per person is permanently higher as a result of the increase in the investment rate, but the growth rate is unchanged. This is sometimes called a long-run “level effect.”
What factors create transition dynamics?
changing any parameter of the model—s̅, d̅, z̅, L̅, ℓ̅, K̅0, or A̅0—will create transition dynamics
