Lecture 7 - 11/2/2009 THESOLOWGROWTHMODEL EC205.01 FALL2009...

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11/2/2009 1 THE SOLOW GROWTH MODEL EC205.01 FALL 2009 ALPER 1 Income & Poverty in the World, 2000 50 60 70 80 90 100 opulation per day or less Madagascar India Bangladesh Nepal Botswana China Kenya 0 10 20 30 40 $0 $5,000 $10,000 $15,000 $20,000 Income per capita in dollars % of p living on $2 Mexico Chile S. Korea Brazil Russian Federation Thailand Peru EC205.01 FALL 2009 ALPER 2 Source: William Easterly (2001), The Elusive Quest for Growth , MIT Press. Standard of living across countries EC205.01 FALL 2009 ALPER 3
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11/2/2009 2 Why growth matters y Anything that effects the long run rate of economic growth –even by a tiny amount – will have huge effects on living standards in the long run. () t t0 Y1 g Y =+ EC205.01 FALL 2009 ALPER 4 percentage increase in standard of living after… annual growth rate of income per capita …25 years …50 years …100 years 2.0% 2.5% 64.0% 85.4% 169.2% 243.7% 624.5% 1,081.4% Why growth matters y If the annual growth rate of U.S. real GDP per capita had been just 0.1 % higher during the 1990s, the U.S. would have generated an additional $496 billion of income during that decade (measured in 2006 prices) income during that decade. (measured in 2006 prices) y If the annual growth rate of Turkish real GDP had been 1% higher between 1999 – 2007, Turkey would have generated an additional 9 billion TL of income measured in 1998 prices during the period. (7,700 billion TL measured in 2007 prices) EC205.01 FALL 2009 ALPER 5 The lessons of growth theory… y … can make a positive difference in the lives of millions of people… y These lessons help us y Understand why poor countries are poor y Design policies that can help poor countries to grow y Learn how growth rate of an economy is affected by shocks and government policies EC205.01 FALL 2009 ALPER 6
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11/2/2009 3 THE SOLOW MODEL y due to Robert Solow (won Nobel Prize for contributions to the study of economic growth) y a major paradigm: id l d i li ki y widely used in policy making y benchmark against which most recent growth theories are compared y looks at the determinants of economic growth and the standard of living in the long run EC205.01 FALL 2009 ALPER 7 Differences between the Solow model and the classical model of income determination 1. K is no longer fixed: investment causes it to grow, depreciation causes it to shrink 2 L is no longer fixed 2. is no longer fixed: population growth causes it to grow 3. the consumption function is simpler 4. no G or T (only to simplify presentation; we can still do fiscal policy experiments) 5. cosmetic differences (such as notation, etc.) EC205.01 FALL 2009 ALPER 8 The production function y In aggregate terms: Y = F ( K , L ) y Define: y = Y/L = output per worker k = K/L = capital per worker y Assume constant returns to scale: zY = F ( zK , zL ) for any z > 0 y Pick z = 1 /L . Then Y/L = F ( K/L , 1 ) y = F ( k , 1 ) y = f ( k ) where f ( k ) = F ( k , 1 ) EC205.01 FALL 2009 ALPER 9 f ( k ) is the “per worker production function,” it shows how much output one worker could produce using k units of capital
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11/2/2009 4 The production function Output per worker, y f(k) 1 MPK = f ( k + 1 ) f ( k ) EC205.01 FALL 2009 ALPER 10 Capital per worker, k
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Lecture 7 - 11/2/2009 THESOLOWGROWTHMODEL EC205.01 FALL2009...

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