Long-Run Economic Growth Flashcards
Economic Growth
An increase in the quantity and quality of goods and services
Production Function
Basic hypothesis — GDP is “created” by factors of production
Main tangible factors:
1. Labour and Human Capital
2. Physical Capital
“Intangible” factor:
Total Factor Productivity
Cobb-Douglas production function
Represents output quantity as a function of inputs
Factor Shares
Total earnings of each factor
Returns to Scale
Constant Returns to Scale indicate that when both K and L are increased by the same percentage amount, say 3%, then output increases by 3%, too.
However, production is still characterized by diminishing marginal returns. That is, holding one-factor constant and increasing the other, the marginal productivity of the other is always positive but diminishes. That is each additional unit of input increases output by progressively smaller amounts.
The Solow Growth Model
An exogenous model of economic growth that analyzes changes in the level of output in an economy over time as a result of changes in the population growth rate, the savings rate, and the rate of technological progress.
The Solow Growth Model: Maximize Profits
The Solow Growth Model: Incomes per Capita
In the long run, the Solow growth model predicts that incomes per capita should not grow.
Economic Prosperity
In the Solow model, growth is driven by:
1. Factor accumulation
2. Productivity
Natural first question: How much of growth is driven by factor accumulation, especially investment (K)?
Growth Accounting: Production Functions
“Labor productivity” measures the total factor productivity and the amount of capital per worker
Total Factor Productivity: Solow Residuals
The Solow residual represents growth in output which cannot be explained by growth in inputs (K and L) and CRTS.
Growth theorists argued that the Solow Residual was a measure of technological change.
This is problematic for two reasons:
- Technology, believed to be one of the main drivers of economic growth, is exogenous, that is, is determined outside the model.
- A very large part of total growth cannot be explained by the model.
New Growth Theory
How could we explain the growth in Y, which cannot be explained by the growth in K, L, and CRTS?
- Technology (R&D)
- Human Capital (education)
- Financial Market Development.
- Increasing Returns to Scale.
These represent elements of the new growth theory that allow economists to explain growth.
Personal Assessment
What does it mean for a production technology to display constant returns to scale?
What are the drivers of differences in income per worker across countries?
What is the Solow residual and what does it measure?
What are contributors to differences in productivity (Solow residual) across countries?
