CHAPTER
10
The Facts of Growth
Prepared by:
Fernando Quijano and Yvonn
Quijano
And modified by Gabriel
Martinez
The Facts of Growth
• We now turn from the determination of
output in the short and medium run—
where fluctuations dominate—to the
determination of output in the long run—
where growth dominates.
• Growth is the steady increase in
aggregate output over time.
© 2003 Prentice Hall Business Publishing
Macroeconomics, 3/e
Olivier Blanchard
Growth in Rich
Countries Since 1950
• Output per capita equals GDP divided by
population.
• The standard of living depends on the
evolution of output per capita
– not total output.
• To compare GDP across countries, we use a
common set of prices for all countries.
Adjusted real GDP numbers are measures of
purchasing power across countries, also
called purchasing power parity (PPP)
numbers.
© 2003 Prentice Hall Business Publishing
Macroeconomics, 3/e
Olivier Blanchard
Growth in Rich
Countries Since 1950
From the data in table 10-1 we conclude
that:
1. The standard of living has increased significantly
since 1950.
2. Growth rates of output per capita have decreased
since the mid-1970s.
3. There has been convergence, that is, the levels of
output per capita across the five countries have
become closer over time.
4. The difference between output per capita in the
United States versus the other countries is now
smaller than it was in the 1950s.
© 2003 Prentice Hall Business Publishing
Macroeconomics, 3/e
Olivier Blanchard
Growth in Rich
Countries Since 1950
Growth Rate of GDP per Capita Since 1950 versus GDP
Per Capita in 1950; OECD countries
Countries that had a lower level of output per capita in 1950
have
typically
grown
faster.
© 2003
Prentice
Hall Business
Publishing
Macroeconomics, 3/e
Olivier Blanchard
10-3
Thinking About
Growth: A Primer
• To think about the facts presented in the
previous sections, we use the framework
of analysis developed by Robert Solow,
from MIT, in the late 1950s. Particularly:
– What determines growth?
– What is the role of capital accumulation?
– What is the role of technological progress?
© 2003 Prentice Hall Business Publishing
Macroeconomics, 3/e
Olivier Blanchard
The Aggregate Production Function
• The aggregate production function is a
specification of the relation between
aggregate output and the inputs in
production.
Y  F(K, N )
Y = aggregate output.
K = capital — the sum of all the machines, plants, and office
buildings in the economy.
N = labor — the number of workers in the economy.
The function F, tells us how much output is produced for given
quantities of capital and labor.
© 2003 Prentice Hall Business Publishing
Macroeconomics, 3/e
Olivier Blanchard
The Aggregate Production Function
• The aggregate production function depends
on the state of technology. The higher the
state of technology, the higher Y  F ( K , N )
for a given K and a given N.
© 2003 Prentice Hall Business Publishing
Macroeconomics, 3/e
Olivier Blanchard
The Aggregate Production Function
• Technology
– is the body of knowledge available to a
civilization
(skills, scientific methods and materials)
and the organization of the economy
(firm and market structure, government
structure and laws) for making goods and
supplying services.
– The production processes (the blueprints,
the instruction manuals) that define the
range of products and the techniques
available to produce them.
© 2003 Prentice Hall Business Publishing
Macroeconomics, 3/e
Development
Economics
Economics
of Growth
Olivier Blanchard
Returns to Scale and Returns to
Factors
• Constant returns to scale is a property of
the economy in which, if the scale of
operation is doubled—that is, if the
quantities of capital and labor are
doubled—then output will also double.
2 Y  F ( 2 K ,2 N )
 Or more generally,
xY  F ( xK , xN )
 An increase in scale is an increase in all
inputs by the same proportion.
© 2003 Prentice Hall Business Publishing
Macroeconomics, 3/e
Olivier Blanchard
Returns to Scale and Returns to
Factors
• What if we increase only 1 input while leaving all
others constant? Output may increase, but
there may be
• Decreasing returns to capital: increases in
capital lead to smaller and smaller increases in
output as the level of capital increases.
• Decreasing returns to labor: increases in
labor, given capital, lead to smaller and smaller
increases in output as the level of labor
increases.
© 2003 Prentice Hall Business Publishing
Macroeconomics, 3/e
Olivier Blanchard
Output per Worker and
Capital per Worker
• Constant returns to scale implies that we
can rewrite the aggregate production
function Y  F ( K , N ) as:
 K N
 K 
 F
,   F
,1



N
N N
N 
Y
 The amount of output per worker, Y/N
depends on the amount of capital per worker,
K/N.
 As capital per worker increases, so does
output per worker.
© 2003 Prentice Hall Business Publishing
Macroeconomics, 3/e
Olivier Blanchard
Output per Worker and
Capital per Worker
Output and Capital
per Worker
Increases in capital
per worker lead to
smaller and smaller
increases in output
per worker.
An increase in capital
per worker, K/N,
causes a move along
the production
function.
© 2003 Prentice Hall Business Publishing
Macroeconomics, 3/e
Olivier Blanchard
The Sources of Growth
The Effects of an
Improvement in the
State of Technology
An improvement in the
state of technology
shifts the production
function up, leading to
an increase in output
per worker for a given
level of capital per
worker.
© 2003 Prentice Hall Business Publishing
Macroeconomics, 3/e
Olivier Blanchard
The Sources of Growth
• Growth comes from capital
accumulation and from technological
progress.
• Because of decreasing returns to capital,
capital accumulation by itself cannot
sustain growth.
© 2003 Prentice Hall Business Publishing
Macroeconomics, 3/e
Olivier Blanchard
The Sources of Growth
• The saving rate is the proportion of
income that is saved.
– A higher saving rate increases the growth of
output, although not permanently.
– Two countries with different rates of saving
will eventually grow at the same rate.
– But the country with a higher saving rate will
have a higher level of output per capita.
© 2003 Prentice Hall Business Publishing
Macroeconomics, 3/e
Olivier Blanchard
The Sources of Growth
• Sustained growth requires sustained
technological progress.
– The rate of growth of output per capita is
eventually determined by the economy’s rate
of technological progress.
© 2003 Prentice Hall Business Publishing
Macroeconomics, 3/e
Olivier Blanchard