Part 2
Ouput per capita
Per capita Cobb-Douglas production function
4.5
4
3.5
3
2.5
2
1.5
1
0.5
0
0
10
20
30
40
50
60
Capital per capita
70
80
90
100



In Easterly's
discussion of
diminishing returns,
when is diminishing
returns more severe?
Explain.



In cases where the variable input is
of minor importance in comparison
to the fixed input, diminishing
returns can be more severe.
Easterly’s notes that if one tries to
increase pancake production by only
increasing salt (ceteris paribus) the
result would be disastrous.
Thus it is important to ask, for the
US (and many countries ) what is
capital income as a % of GDP? It is
only about 1/3 – the rest is labor
income.
This means that diminishing returns
are going to be more severe if
countries try to increase
savings/investment to boost capital!
When machines are plentiful, the
additional output of adding one
more machine is very very low.



Explain Solow’s view
on what would not
sustain growth.
How did this lead to
Solow’s surprise?
Explain how Solow’s
surprise can solve
the problem of
diminishing returns
and leads to growth.



Increasing machines would not sustain
growth. It may be high at first if
machines are scarce; but diminishing
returns means that the growth would
fall as machines become abundant.
Savings will not sustain growth because
this just diverts expenditures from
consumption today into more
machines…But while higher saving
economies will have higher income
(level effect) than a low-saving
economy, growth would not be
sustained by savings.
The Solow surprise is that the growth of
output per worker (output per capita)
could not be sustained. This leads to
the question of “but what does sustain
growth”?
Answer: technological change. It is this
change in technology that may stave off
diminishing returns to capital because it
effectively gives us “new workers” really the workers can each produce
more with this new technology, so there
is no diminishing returns to capital.




Solow’s model
shows that the poor
will eventually catch
up to the rich. What
does the data show
has actually
happened?
Include in your
answer Baumol’s
findings.
.


Evidence against Solow’s model was the
continued lack of growth in many poor
countries. Romer used data from
1960-1981 to show that Solows
prediction of growth failed in the
tropics.
Pritchett also showed that even as far
back as 1820, countries that are
wealthy by 1992 were also the wealthy
in 1820 – income divergence has just
intensified.
But…Baumol showed that a group of 16
industrial countries had caught up to
the leader over the past century; the
poor had grown faster than the rich and
thus there was a tendency toward
conversion of national incomes.
Baumol’s Findings




Question continued:
So did the poor
catch up with the
rich?
Include in your
answer Baumol’s
findings and de
Long’s critique.



Evidence against Solow’s model was the
continued lack of growth in many poor
countries. Romer used data from
1960-1981 to show that Solows
prediction of growth failed in the
tropics.
Pritchett also showed that even as far
back as 1820, countries that are
wealthy by 1992 were also the wealthy
in 1820 – income divergence has just
intensified.
Baumol showed that a group of 16
industrial countries had caught up to
the leader over the past century; the
poor had grown faster than the rich and
thus there was a tendency toward
conversion of national incomes.
de Long of Berkeley pointed out the
mistake; Baumol chose for his study
countries that had become wealthy –
thus “proved” his conclusion by
selecting only countries that had
become wealthy – selected countries
that had converged. This is called
“sample selection bias”.
De Long’s Criticism