Week 2: Economic Growth Flashcards
Economic Growth
Long-run improvements in living standard
Operational Economic Growth
Long-run increases in GDP per capita
Why is economic growth important?
Small changes in annual growth can have a large impact of the growth levels in the future
What is the Rule of 70?
Practical approximate rule to understand the implications of economic growth
The Rule of 70
If y grows at a rate of g then the numbers of years it takes y to double is approx equal to 70/g
What do small differences in growth rates result in over time?
Large differences in growth over time
What does the time it takes to double economic growth depend on?
the growth rate (not the initial value)
Long-Run Economic Growth - Before Industrial Revolution
Little difference between countries and time - no sensible increase of living standards
Long-Run Economic Growth - After Industrial Revolution
Per capita real income growth has been close to 2% per year since 1900 in most developed countries
Long-Run Economic Growth between 1800 and 1950
Gap in per capita income extremely widens during this period and creates two groups - W Europe, US, Canada, Australia, NZ and rest of the world
Correlation between Real Per Capita Income and Rate of Population Growth
Negative correlation
Trend in hours worked over time in developed economies?
Increased
Production Function (Definition)
Shows how much output (Y) can be produced given any number of inputs
Production model
Single, closed economy
One consumption good
Inputs in the production process
Labour: L
Capital: K
Production Function (Equation)
Y = F(K,L) = AK^1/3L^2/3 Y = output F(K,L) = output A = productivity parameter K^1/3L^2/3 = inputs (capital and labour)
3 ways that Y can change in the production function?
- Capital changes (K)
- Labour force changes (L)
- Ability to produce goods with given resources (K.L) changes
Cobb-Douglas Production Function (Equation)
Y = K^⍺L^1-⍺
⍺ is assumed to be 1/3
Function exhibits constant returns to scale
Constant Returns to Scale
When an increase in inputs (capital and labour) cause the same proportional increase in output
If K and L increase by x% then Y also increases by x%
Output per Worker Equation
MaxProfits Equation for Allocating Resources
maxπ = F(K,L) - rK - wL π = profits r = rent of capital w = wage rate
Marginal Product of Labour (MPL)
the change in output that results from employing an added unit of labour
Marginal Product of Capital (MPK)
the change in output that results from employing an added unit of capital
Allocating Resources Model: Up to what point do we hire capital and labour?
Hire capital until MPK = r
Hire capital until MPL = w
What does the solution imply from the allocating resources model?
Firm employs all supplied capital and labour in economy
What Does Equilibrium in Production Function Mean? (3 points)
All income is paid to capital or labour
Results in zero profit in the economy
Verifies the assumption of perfect competition
If MPK is higher in poor countries with low K - why doesn’t capital flow to those countries?
A simple production model with no difference in productivity across countries is misguided
Productivity Parameter
measures how efficiently countries are using factor inputs
TFP – Total Factor Productivity
measure of productive efficiency in that it measures how much output can be produced from a certain numbers of inputs
What do levels of TFP imply? (Lower Level and Higher Level)
Lower level - workers produce less output for any given level of capital per person
Higher level - workers produce more output for any given level of capital per person
Annual Growth Rate in GDP per capita (Over period of 1+ years)
g = (GDP1/GDP2) ^1/n -1 n = number of years in period
TFP Equation
Take cobb-douglas production function and solve for A
How to use rule of 70 with growth rates?
Divide 70/g
where g = growth rate
How to use rule of 70 with growth rates?
Divide 70/g
where g = growth rate
What does it mean for a country if TFP is higher compared to another country?
MPL is also higher
In turn wages must be higher
What happens when workers move from an area of lower TFP to an area of higher TFP? Why?
- Labour input increases in the area with higher TFP and decreases in the area with lower TFP
- Wages decrease in the area of higher TFP and increase in the area with lower TFP - due to changes in the marginal product of labour
- Process stops when wages are equalised
How to work out if a production function has increasing, decreasing or constant returns to scale?
Take function and substitute in an input and obtain result. Then double input and the change in output will confirm the returns to scale
