Chapter 4: Romer Model Flashcards
What does the Romer model divide the world into?
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Objects:
- All goods (E.g. Capital and labour)
- Finite
- They are rivalrous, meaning that one person’s use of an object inhibits someone else’s use.
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Ideas:
- Recipes to create objects
- Infinite
According to the Romer model, what causes long term growth?
Economic growth occurs as we discover better and better ways to use the finite resources available to us. In other words, sustained economic growth occurs because we discover new ideas. Ideas are fundamental because they are non-rivarly.
- Researchers produce new ideas, and the sustained production of these new ideas leads to the sustained growth of income over time.
- no diminishing returns to the existing stock of ideas here—the exponent on A is equal to 1.we accumulate more knowledge, the return to knowledge does not fall. Old ideas continue to help us produce new ideas in a virtuous circle that sustains economic growth.
What is the first and second welfare theorem?
Perfectly competitive markets leads to efficent allocation of resources
Idea diagram
What is rival?
- One person’s use of a particular object reduces its inherent usefulness to someone else
- gives rise to scarcity, the central subject of economics.
- Cannot be used at two places at one time
Non rival:
- one person’s use of a particular object does not reduces its inherent usefulness to someone else
- Once an idea has been introduced, it can be employed by an arbitrary number of people without anyone’s use being degraded.
Excludability
Excludability refers to the extent to which someone has property rights over a good—possibly an idea—and is legally allowed to restrict the use of that good.
Characterisitcs of ideas
- Infinite
- Non-rivarly
- Ideas can be non-excludabe in principle but can be excludable, as they introduced legal restricitions and these provide an incentive (E.g. Profits)
What are the returns to scale of the Romer model?
Increasing returns to scale: Average production per dollar is rising as the scale of production increases
Doubling input will more than double output
High fixed development cost, as the cost of developing a new idea is high. Any time new ideas are invented, there is a fixed cost to produce the new set of instructions. After that, production proceeds with constant returns to scale and therefore constant marginal cost. But in order for the innovator to be compensated for the original research that led to the new idea, there must be some wedge between price and marginal cost at some point down the line. One of the main reasons new goods are invented is because of the incentives embedded in the wedge between price and marginal cost.
What is the proof to show the Romer model has an increasing returns to scale?
- Knowledge is an input as it can be created (so it has a subscript, t), which means there is an increasing returns to scale as a result of multiplying is greater than the inital increase
- Production has labour, capital and knowledge as a production function
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What is pareto optimal?
A situation in which no one can be made better off without someone being made worse off
What are the problems with pure competition?
- Allocation is pareto optimal
- P=MC, but when there is a fixed costs firms are making a loss, disincentive as firms make no profit if they have an increasing returns to sclae.
- So if prices are equal to marginal cost, no firm will undertake the costly research that is necessary to invent new ideas. A price greater than marginal cost allows the producer eventually to recoup the original research expenditures.
Patents:
- Grant monopoly power over a good for a period. Provides a temporary wedge between price and marginal cost that leads to profits. The profits, in turn, provide the incentive for the innovator to seek out the new idea in the first place.
- Generate positive profits, as able to charge above MC
- Provide inventives for innovation
P>MC results in a welfare loss (Pareto allocation)
Other incentives may lead to a welfare loss
- Government funding
- Prizes provide an incnetive to find a solution
In order to enagage with ideas, it causes a welfare loss
What is the Romer model production function?
- Neglect capital to focus on main engine of growth
What are other reasons beside profit that promote innovation?
Altuisitic generosity
Desire to signal skills
Purpose motives
E.g. Linux, Apache
Increasing ideas:
Δ At+1 ≡ At+1 − At
- Existence of ideas in previous period (At)
- Number of workers producing ideas (Lat)
- Worker productivity in the research sector ( z̅).
Because ideas are non-rival, the new workers can use the exisiting stock of ideas. There are therefore increasing returns to ideas and objects in the production function.
Unregulated market underprovides ideas therefore government subsidies should be used
Population in the Romer model
- Lat: Number of workers producing ideas
- Lyt: Number of workers in the manufacturing sector
Labour force = Lyt + Lat
z̅
productivity parameter of workers in the research sector
What are the unknown/ endogenous variables?
- Yt - Outut, at time, t
- At - Existence of previous ideas
- Lyt - Number of workers in the manufacturing sector/ producing output
- Lat - Number of workers in the research sector
What are the parameters?
- z̅ - Productivity of the research sector
- L̅ - Total number of workers
- ℓ̅ - Proportion of workers in the research sector
- A̅0 - Inital level of ideas
output per person:
Growth rate of ideas (g̅ )
- In the Solow model, output per person depends on capital per person
- Growth rate is constant and continues, therefore constant growth of GDP
What is an equation to show the stock of knowledge?
Combining output per person and stock of ideas to produce an equation for output per person, where all the factors are parameters
Constant growth of GDP per capita
Balanced growth path
No transition dynamics
balanced growth path, where the growth rates of all endogenous variables are constant.
Why does it not make sense to use the Romer model for countries?
Once ideas are produced they can be used anywhere, therefore it is better to look at the model from a world perspective.
Population increase
- Green factor increases and therefore the blue square increases
- Growth rate increases permenantly, therefore growth in GDP per capita
- Change in gradient shows that there is a change in growth rate.
Michael Kremer of Harvard University has suggested that this could be the result of a virtuous circle between ideas and population. People create new ideas, and new ideas make it possible for finite resources to support a larger population. The larger population in turn creates even more ideas, and so on
Increasing the research share
- Faster production of ideas
- Because there are less workers in the output sector, output decreases and GDP per capita falls but because growth rate increases, the economy moves at a faster rate
What is the growth effect?
Changes to the rate of growth of per capita output
If the exponent of ideas is not equal to 1, the growth effect will be eliminated in the long run, as changes in growth rate are temporary and we return to the original growth effects
What is the level effect?
Changes in the level of per capita GDP but does not affect the long-run growth rate
What would happen if the exponent of ideas is not equal to 1?
There will be sustained growth
Growth effects will be eliminated
