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