Economic Growth
Professor Chris Adam
Australian Graduate School of Management
University of Sydney and University of New
South Wales
1
INTRODUCTION
• Observe rising incomes and standards of
living
• Know that level of GDP driven by
– Capital
– Labour
– Technology
• Changes in GDP must come from changes
in factors
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REAL GROWTH
3
GROWTH OF COUNTRIES
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GROWTH MODEL
• Solow-Swan growth model (1956)
– “Dynamic capital accumulation”
– Can explain how growth occurs
– Can explain differences in growth
– Key elements are savings and population
growth
– Technological progress also important but not
covered here
5
GROWTH MODEL
• Supply of goods and production
Y = F(K, L)
– Constant returns to scale
– Analyze all quantities relative to labour force:
Y/L = F(K/L, 1) or
y = f(k)
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GROWTH MODEL
• Supply of goods and production
– Slope of function is marginal productivity of
capital per worker
– Slope declines with increased capital per
worker
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LABOUR PRODUCTIVITY
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GROWTH MODEL
• Demand for goods and consumption
– Output per worker divided between
consumption goods and investment goods
y=c+i
– Omits government and international sectors
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GROWTH MODEL
• Demand for goods and consumption
– Savings is fraction 0 < s < 1 of income, so
consumption is
c = (1 – s)y
– Implies investment equals saving: i = sy
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USING GROWTH MODEL
• Capital stock growth and steady state
– Investment (i) increases capital stock = savings
(sf(k)) increases capital stock
– Depreciation reduces capital stock: depreciation
rate = d
– Change in capital stock Dk then
Dk = i – dk
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USING GROWTH MODEL
• Capital stock growth and steady state
– Steady state when Dk = 0
– implying i = sf(k*) = dk* for k* steady state
(constant) capital per worker
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USING GROWTH MODEL
• How savings affects growth
– Increased savings rate (s) means less
consumption per worker and more investment
– Leads to higher level of capital stock per
worker (k)
– Strong empirical support
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SAVINGS
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USING GROWTH MODEL
• What determines savings rates?
• Similar investment rates do not always
produce same income per worker – what
else matters?
15
GOLDEN RULE OF
GROWTH
• Is more savings always good?
– Gives larger capital stock per worker and higher
output per worker
– But reduces consumption per worker
• Want to compare steady states to see
which has highest consumption per worker
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GOLDEN RULE OF
GROWTH
• Consider level of consumption at steady
state
c* = f(k*) – dk*
Consumption is what is left of steady state output
after allowing for steady state depreciation
• Set level of savings to ensure c* is
maximized: this is Golden Rule Savings
– occurs when marginal product of k equals d
17
TRANSITION TO GOLDEN
RULE
• Too much capital per worker:
– Policy maker lowers saving rate to Golden Rule
level
– Increases consumption and reduces investment
– Investment rate now below depreciation rate
– Reduces output, investment further
– Consumption decreases from peak, but will
remain above original level since at Golden Rule
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TRANSITION TO GOLDEN
RULE
• Too little capital per worker:
– Policy maker increases saving rate to Golden Rule
level
– Reduces consumption and increases investment
– Investment rate now above depreciation rate
– Increases output, investment further
– Consumption increases from dip, and will remain
above original level since at Golden Rule
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POPULATION GROWTH
• Growth in population increases workforce
– Dilutes capital and output per worker at steady
state
– Population growth rate (n) reduces capital stock
per worker in same way as depreciation
Dk = i – (d + n)k
= sf(k) – (d + n)k
• Steady state k* from
Dk = 0 = sf(k*) – (d + n)k*
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POPULATION GROWTH
• Growth in population has three effects on
growth:
– Better view of sustained growth drivers: total
output grows
– Better view of national income differences:
higher population grow lowers GDP per person
– Golden Rule adjusted: now marginal product of
capital per worker to equal (d + n)
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TAKEAWAYS
• Solow-Swan model shows
– How saving sets steady state capital stock per
worker and steady state income per worker
– How population growth sets steady state capital
stock per worker and steady state income per
worker
– What policy makers might do to maximize
consumption per worker in steady state
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