Topic 3
Overview: Examine HOW we can promote growth
Key Facts:
1. Per capita GDP today varies among nations
o 10% of the world’s population – live in a country with GDP per
capita less than $1500
o 75% of the population- less than average
o Most of the world’s population is poor to the U.S
2. Everyone used to be poor
3. Growth miracles and growth disasters
o Japan after World War 2, poorest ->now one of the richest
o Argentina used to be used now poor
Rule of 70
Growth builds on growth
If the annual growth rate of a variable is x% - doubling rate is 70/x years
Determinates of Growth; Proximate Causes
1. Proximate (Direct) causes of growths are the factors of production
o Physical Capital: stock of tools, structure, equipment
o Human capital: knowledge and skills workers acquire
o Technology: knowledge about how the world works that is used
to produce
2. Economy grows by: skilled labor, machines, foreign investment
3. Ultimate (indirect) causes of growth are INSTITUTIONS
o Freedom, democracy, rule of law, property rights, honest
government, no wars
Solow Growth Model
 Provides a theory to explain the factors that influence
o Cross Country differences in per capita income
o Differences in growth rates over time
 It relates savings, investment, and output to the production function
Setup
-
Output (Y)
Physical capital (K)
Labor (L)
Human capital (eL)
Technology (A)
A function that relate A, K, eL and Y  F()
********** Y = F(A, K, eL) ***********
Simplicity, we assume
- F() is square root
- Ignore “eL”
A=1
********** Y = K0.5 = √𝒌 ***********
Diminishing marginal returns: the marginal (addition) product of capital
diminishes as more capital is added
2
Where does capital come from
- Saving: for every dollar you earn, a portion of it is saved
- Uses saving to invest for the next period
- Assumption saving = investment
K=81
K=225
Y
9
15
S
0.3x9=2.7
0.3x15=4.5
I
2.7
4.5
C
6.3
10.5
Depreciation:
 Capital will also deteriorate
o Ex) machines break down, roads wear out
When will capital stock grow?




Production function
Saving
Investment
Depreciation
Investment > Deprecation
 Capital increases
Investment < depreciation
 Capital decreases
Investment = Depreciation
 Capital stays the same
3
0.3 k = 0.002k
0.3/0.2 √𝑘= k
15 √𝑘 = k
15 = √𝑘
225 = k0.5
4