ROMER MODEL Flashcards
The romer model is about…
How the process of ideas can generate economic growth.
The economics of ideas involves 2 things:
- IRS in production
2. Problems with perfect competition
2 classes of FOPs
Objects
Ideas
2 difference between objects and ideas
- potentially infinite ideas vs finite objects
2. Ideas are non-rival vs rival ideas
Why are ideas non-rival?
because one person’s use of an idea do not prevent its inherent usefulness to someone else.
Why are objects rival?
Because one person’s use diminishes the stock / reduces usefulness to someone else in terms of efficiency.
How can ideas be made excludable?
By legal boundaries such as property rights
2 implications of non-rivalry
- IRS in production due to replication argument - if we double objects, production doubles, so if also double ideas, production will more than double.
- Innovation not compatible with perfect competition
Why is innovation not compatible with perfect competition?
Perfect comp: price = MC
Zero profits
Innovation incurs an additional fixed cost
If non-rival any firm can use so no firm willing to incur the loss for it. Need market power.
Simplification of Romer model
NO physical capital Kt
4 equations romer
- production of goods: Yt = At Lyt
- ideas pf: change At+1 = z bar At Lat
- Resource constraint: Lyt + Lat = L bar
- Allocation of labour: Lat = l bar L bar
Ideas production function & explain
change At+1 = z bar At Lat
z bar = productivity of ideas production
At = stock of existing ideas ‘standing on shoulder of giants’
Lat = no workers in R&D
Output per worker pf romer. Explain.
yt = At (1-l bar)
Output per worker depends on total stock of ideas since non-rival so total stock available to every worker.
Growth rate of knowledge =
change At+1/At = z bar l bar L bar
g bar = z bar l bar L bar
Stock of knowledge at time t
At = A0 (1+g)^t
Output per worker solved in terms of parameters only
yt = A0 (1- l bar) (1+g)^t
So does Romer model produce LR growth?
YES - output per worker grows at a constant rate g over time.
Why does Romer –> LR growth?
Because idea are non-rival - no diminishing returns + no depreciation.
Transition dynamics in romer?
NO - because at all times all endogenous variables grow at constant rate g - no periods of varying growth.
What do we call the LR in romer?
Balanced growth path
impact of higher L bar on romer
Higher L bar = increases g bar = increases output per worker. Immediate and permanent increase in growth rate per worker = scale effect.
Are scale effects data consistent?
NO - countries with large LF do not grow faster. But can’t be sure as we don’t know whether the correct boundaries for flow of ideas is actually countries.
impact of higher l bar on romer
higher l bar = reduces yt in SR
higher l bar = higher g bar = increases yt and growth in LR. SR trade-off.
Does Romer predict convergence?
NO - two economies one with higher A0 and same growth = constant GDP level gap. Otherwise divergence.
How do we combine solow and romer?
Non rival ideas from romer = LR growth along balanced growth path. Transition dynamics to balanced growth path from solow.
Add endogenous K accumulation from solow into romer.
Solow romer model equation
Yt = At Kt^1/3 Lyt^2/3
Explain transition dynamics solow romer
When K stock is low, high MPK= K accumulation generates growth, as well as ideas, so g > g bar. In LR, K stops generating growth, only comes from ideas so g = g bar.
gyt solow romer =
gyt = gAt + 1/3 gKt + 2/3 gLyt
gLyt solow romer =
0
gAt solow romer
g = z bar l bar L bar
In order for growth rate of K to be constant on balanced growth path, what do we need?
Capital output ratio to be constant.
So gYt = gKt
Therefore, growth rate of output in solow romer =
gYt = g bar + 1/3 gYt
2/3 gYt = g bar
gYt = 3/2 g bar = 3/2 z bar l bar L bar
What is the growth rate of output PER WORKER solow romer?
SAME as growth rate of output
gyt = 3/2 g bar = 3/2 z bar l bar L bar
Since L bar is fixed
Compare LR growth rate solow romer vs romer & explain.
3/2 g > g
Combined model generates higher growth on balanced growth path due to At leading to direct increase Yt and indirect increasing K accumulation which increases Yt.
Output per person on balanced growth path solow romer
yt* = (s bar / gY* + d bar)^0.5 At^3/2 (1- l bar)
So impact of increasing s bar on Output per person on balanced growth path
SR growth from K accumulation
In LR on a new balanced growth path with higher level of GDP per capita, but same growth rate as before.
2 ways to increase g bar in solow romer
- Increase share of LF in R&D
2. Increase productivity of ideas production process.
