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L4_Harrod%20Domar_Solow

# L4_Harrod%20Domar_Solow - Classical Growth Models(cont...

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4/8/2010 1 Classical Growth Models (cont.) Harrod-Domar April 8, 2010 ARE/ECN 115A Business For Tuesday: Solow Model PRL 117 133 PRL: pp.117 – 133 Easterly Ch. 3 “Solow’s Surprise” Homework 1 Available on SmartSite Due at beginning of class Tuesday, April 20

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4/8/2010 2 Outline for Today Finish H-D R i h l i d l i H D Review technology assumption underlying H-D Put together model Find out what H-D predicts in terms of Determinants of long-run growth; Role of government policy in raising growth rates; Expectations of international income dynamics Expectations of international income dynamics. Perhaps start in on Solow I But first…a little present Review of Last Time Technology underlying Harrod-Domar model
4/8/2010 3 Important Assumptions Closed Economy No Government Single Sector Technology: F(K,L) CRTS Fixed Coefficient (Leontief) Isoquants for Fixed-Coefficient Technology Implication 1 : Always produce at “Elbow” of isoquants

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4/8/2010 4 K/L ratio constant Examine expansion from a to b: At a: K/L = \$10M/100 = 100,000 At b: K/L = \$20M/200 = 100,000 As output expands, always use capital and labor in the same fixed proportion. CRTS: Examine expansion from a to b: L doubles from 100 to 200 K doubles from \$10M to \$20M Q doubles from 100,000 to 200,000 keyboards
4/8/2010 5 I li i f CRTS & Fi d C ffi i T h l Implication of CRTS & Fixed Coefficient Technology : At a: K/Y = 10M/(100,000Kbs * \$50/Kb) = 10M/5M = 2 At b: K/Y = 20M/(200,000Kbs * \$50/Kb) = 20M/10M = 2 K/Y is constant at any point on the expansion path (elbow) i.e., Constant Capital-Output Ratio An additional unit of K always generates the same increase in output. Closer Look at Capital-Output Ratio In our example: K/Y = 2 Q What q estion does capital o tp t ratio answer? Q: What question does capital-output ratio answer? A: How many units of capital are needed to produce one unit of output? Notice that the capital-output ratio is just the inverse of the (average) productivity of capital i.e., Y/K = ½ On average, we get one-half units of output for each unit of capital. Implication of constant capital-output ratio: No matter what level of Y we’re at, we always need the same additional amount of capital to increase Y by 1 unit.

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