AREC445 Chapter 4

# AREC445 Chapter 4 - AREC445 Chapter 4- Theories of Economic...

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AREC445 Chapter 4- Theories of Economic Growth Growth depends on two processes: accumulation of assets (capital, labor, land) and making those assets more productive Saving and investment are central, but investments must be productive for growth to proceed Growth is not the same as development, but it remains absolutely central to the development process The Basic Growth Model Our ultimate focus is to explore the key determinants of the change in output, that is, on the rate of economic growth The basic model has five equations: o An aggregate production function o An equation determining the level of saving o The saving-investment identity o A statement relating new investment to changes in the capital stock o An expression for the growth rate of the labor force Standard growth models have at their core one or a series of production functions- at the individual firm or microeconomic level, these production functions relate the number of employees and machines to the size of the firms output At the national or economywide level, production functions describe the relationship of the size of a countrys total labor force and the value of its capital stock with the level of that country’s gross domestic product (its total output)- aggregate production functions Y=F(K,L) o Y represents total output (total income) o K is the capital stock o L is the labor supply The expression indicates that output is a function of the capital stock and the labor supply As the capital stock and labor supply grow, output expands Economic growth occurs by increasing either the capital stock (through new investments), the size of the labor force, or both (F) states precisely how much output expands in response to changes in K and L, is what distinguishes many different growth models These three equations first calculate total saving, then relate saving to new investment, and finally describe how new investment changes the size of the capital stock To calculate saving: S=s x Y o (S) represents the total value of saving o (s) represents the average saving rate In a closed economy, saving must be equal to investment: S=I All output of goods and services produced by the economy must be used for either current consumption or investment, while all income earned by households must

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be either consumed or saved Two main forces determine changes in capital stock: new investments and depreciation: Change in K=I-(d X K) o (D) is the rate of depreciation o (I) indicates that the capital stock increases each year by the amount of new investment o –(d x K) shows that capital stock decreases every year because of the depreciation of existing capital o depreciation rate is constant, usually in the rage of 2 to 10 percent Labor force grows exactly as fast as the total population Change in L=n x L: supply of labor Collectively, they can be used to examine how changes in population, saving, and investment initially affect the capital stock and labor supply and ultimately
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## This note was uploaded on 11/16/2010 for the course AREC 445 taught by Professor Staff during the Spring '08 term at Maryland.

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AREC445 Chapter 4 - AREC445 Chapter 4- Theories of Economic...

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