LECTURE9 (2009) - ECON 1002 Introductory Macroeconomics...

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1 1 Introductory Macroeconomics Week 10 Savings, capital formation and growth ECON 1002
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2 Savings, Investment and Capital Many factors impact economic growth (week 8). However, capital formation (increase in the stock of capital) is a factor that plays a key role. Therefore, Savings and Investment play an important role in economic growth There is a positive relationship between the long run level of GDP per capita and the investment rate ( I as a percentage of GDP) This relationship does not hold for very the less developed countries.
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3 Investment and per capital GDP
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4 National accounting: saving and investment Remember national accounting from WEEK 2: In a closed economy, output equals aggregate expenditure and so: Y = C + I +G In addition, output equals income. It can be spent on current consumption, laid in taxes and saved and so: Y = C + NT + S
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5 National accounting: saving and investment (2) Therefore C + I + G = C + T + S and S + (T – G) = I The LHS of this last equation is national saving (saving + budget balance). Therefore we can see a fundamental link between an economy’s saving and its level of investment. Note that an open economy can draw on international borrowing and lending, which allows S ≠ I
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6 The Solow-Swan model of economic growth Remember from WEEK 8: Robert Solow found that for the period 1909-1949 in the US 80% of the growth in labour productivity was due to technical progress. Technical progress (or Total Factor Productivity) is made possible by high level of investment (without investment, The Solow-Swan model, or ‘Neo-classical Growth Model’, predicts a positive relationship between the level of saving and investment and the long-run level of per capita GDP .
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7 The Solow Swan Growth Model Remember: 1. the Production Function (lecture 8) Y = Af(K , L) where: Y = amount of real output, A = an index of secondary factors available to the firm or TFP K = the capital stock L = amount of labour 2. The per worker production function (lecture 8) y = a f(k) with y: Y/L (real GDP per capita) k: K/L capital per worker a: variable measuring current state of technology and efficiency
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8 The Solow Swan Growth Model According to the per worker production function: The level of per capita GDP depends on the level of total factor productivity and the amount of capital relative to the size of the labour force (K/L = k). This means that the higher the capital stock relative to the labour force, the higher the per capita GDP (albeit with diminishing returns).
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9 Diminishing Returns to k We still assume diminishing marginal productivity. This means the higher the existing capital–labour ratio ( k ), the smaller the increase in GDP per worker ( y ) when there is an increase in k. This makes intuitive sense: one computer will help you to study,
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LECTURE9 (2009) - ECON 1002 Introductory Macroeconomics...

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