lec567(2) - Lecture 5 Economic Growth the Solow Model Eric...

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Lecture 5 Economic Growth: the Solow Model Eric Doviak Economic Growth and Economic Fluctuations Why Study Economic Growth? Is there some action a government of India could take that would lead the Indian economy to grow like Indonesia’s or Egypt’s? If so, what, exactly? If not, what is it about the “nature of India” that makes it so? The consequences for human welfare involved in questions like these are simply staggering: Once one starts to think about them, it is hard to think about anything else. – Robert E. Lucas, Jr. Page 63
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What is Economic Growth? x Before the Industrial Revolution in Great Britain, every society in the world was agrarian. x Then technical change and capital accumulation increased British society’s ability to produce textiles and agricultural products x and a rapid and sustained increase in real output per capita began x As a result, more could be produced with fewer resources o new products o more output and o wider choice x Economic growth shifts the society’s production possibility frontier up and to the right x Economic growth allows each member of society to produce and consume more of all goods Plan of this Lecture x In the previous lecture, we learned some basic measures of how national income is distributed among factors of production and how national income is allocated among the goods produced. x In this lecture, we’ll examine the model of economic growth developed by Robert M. Solow in the 1950s. x The Solow Model was one of the first attempts to describe how: o saving, o population growth and o technological progress x affect the growth of output per worker over time – i.e. we’re looking at LONG RUN economic growth. x We’ll use Solow’s model to examine: o why the standards of living vary so widely among countries and o how economic policy can be used to influence standards of living o How much of an economy’s output should be consumed today and how much should be saved for the future? Page 64
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Demand-Side Assumptions x To simplify the discussion, we’ll examine a closed economy without a government. In other words: o there is no international trade (so net exports equal zero) and o government purchases equal zero x so output is divided among consumption and investment: I C Y . ! x Ultimately, we want to examine living standards, so we want to focus on per capita output, consumption and investment. x It’s easier to examine per worker variables in this model however. x Nonetheless, per worker variables will yield fairly good approximations of living standards, so if we denote the labor force by L , we can define: o output per worker as: L Y y { o consumption per worker as: L C c { and o investment per worker as: L I i { so: i c y . ! Demand-Side Assumptions x Consumption per worker is the amount of output that is not invested i y c 0 !
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