Chapter 7 Study Guide
Chapter 7 Study Guide ECON 2
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This 4 page Study Guide was uploaded by Nolan Shapiro on Monday November 2, 2015. The Study Guide belongs to ECON 2 at University of California - Santa Cruz taught by Aaron Meininger in Fall 2015. Since its upload, it has received 52 views. For similar materials see Intro to Macroeconomic in Economcs at University of California - Santa Cruz.
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Date Created: 11/02/15
Lecture Notes: Catch Up growth: Poor countries tend to grow faster, or "catch up," to rich countries as they adopt the production and technologies of the richest countries. B/c diminishing marginal utility > first few machines will make a much larger than 2001st and 2002nd machines Sustained growth: Some countries experience positive and relatively steady growth rates over 50,100, and 200 year periods. Developed countries A nation can increase its GDP by: 1. Increasing its stock of physical capital K 2. Increasing the total efficiency units of labor, H 3. Improving its technology, A Consider a simply economy where there is no government nor exports nor imports, so that G=X=M=0. Y= C+I for expenditure side Income side Y=C+S (S=savings) Ultimately I=S Consumers save money in banks. Banks lend our saved money to businesses to invest in the machines and new facilities What determines aggregate saving, S? Individual households decide how much of their income and how much they save. Consumption brings instant happiness while savings brings delayed. The individual consumptionsaving decision is ultimately an optimization problem where the relevant price is the interest rate. The sum of these individual decisions determine the saving rate of the economy: Saving rate= total saving/ GDP Physical capital accumulation by itself cannot generate sustained growth due to the diminishing marginal product of physical capital. Why? More and more capital will generate smaller and smaller increases in GDP. Therefore a constant or sustained growth cannot be achieved. Similarly, population growth and education by themselves cannot generate sustained growth due to the diminishing marginal product of labor and diminishing marginal product of skills Why? More and more labor will generate smaller and smaller increases in GDP. Therefore, a constant or sustained growth rate cannot be achieved Technological change The process in which new technologies and new goods and services are invented, introduced, and used in the economy. Such change can generate sustained growth Technological change is more than a constant increase, such as 10 more units. Rather, it is exponential in that the rate of increase is approximately constant, such as 10%. Why? New innovations and technologies build on the existing stock of knowledge "building on the shoulders of giants" and thus are not subject to diminishing returns. The economic history of the world can be broken into: Pre modern times up t0 1800 Industrial revolution 18001820 Post industrial revolution 1820 to present Thomas Malthus, writing in 1798, argues that humankind was destined to live at the subsistence level the minimum level of income 7A The Solow Growth Model Key Ideas] 1. There are three building blocks of the Solow growth model 2. The Solow growth model can be solved for a steadystate equilibrium 3. IN the Solow growth model, increases in the saving rate, human capital, and tech increase the level of real GDP 4. In the Solow growth model, the steadystate equilibrium is dynamic 5. In the Solow growth model, sustained economic growth can be achieved only with increases in tech 6. The compound growth formula is used to calculate average annual growth rates Three building blocks 1. The aggregate production the first block of the Solow growth model 2. An equation for physical accumulation 1. Know= K last year K depreciated + I (new investment) 2. Where K is the stock of capital, and I is the flow of new investment 3. Assuming a constant depreciation rate, the physical capital accumulation becomes: 1. K now= K last year (Depreciation rate x K last year + Investment) 2. K now= (1d) x K last year + I b. I= s (savings rate) x GDP= x A x F (K, H) Total output Y is divided between C and I: Steady State equilibrium An economic equilibrium in which the physical capital stock remains constant over time: K now= K last year= K A steadystate equilibrium occurs when new investment is equal to depreciation: I= depreciation S x Y= d x K S x A x K (K, L) = d x K An increase in either the saving rate, s, or the stock of human capital, h, will increase the output of GDP A dynamic equilibrium traces the behavior of the economy over time. Suppose the economy begins with a physical capital stock of K0<K* K*=quantity at equilibrium Increase in the saving rate, s, is not a source of sustained growth in GDP. Why? Increases in saving shift the investment curve up and thus provide an increase in the level of GDP Technological process is a source of sustained growth in GDP. Why? An increase in tech, a, raises productivity, thus allowing physical and human capital to produce more output. Another prediction of the Solow growth model is that the ration of the physical capital stock to GDP should be constant through time: At steady state, investment=depreciation Catchup growth is driven by the accumulation of physical and human capital. Catchup growth leads to increases in the level of real GDP. Although it can dramatically raise the level of GDP, catchup growth is not a source of sustained growth in real GDP. Compound growth is the phenomenon whereby growth builds on growth. R= P(1+r)^t Book Notes: 7.1 The Power of Economic Growth Economic growth, or growth, is the increase in GDP per capita of an economy The growth rate is the change in quantity, for example, GDP per capita, between two dates, relative to the baseline (beginning of period) quantity > newold/old Exponential growth refers to a situation in which the growth process can be described by an approximately constant growth rate of a variable such as GDP or GDP per capita Exponential growth results because new growth builds on past growth and its effect compound Ex.: Two countries start with the same level of GDP per capita in 1810 at 1,000. One country has a 1% growth rate while the other has a 2%. At first, the differences seem small. Over 200 years, the 1% rate gets to a GDP of 7,316 while the 2% gets to $52,485. This is more than a sevenfold difference. Catchup growth refers to a growth process whereby relatively poorer nations increase their incomes by taking advantage of knowledge and technologies already invented in other, technologically more advanced countries o Usually done by benefiting from available technologies, but also by increasing their saving, efficiency units of labor, and efficiency of production Sustained growth refers to a growth process where GDP per capita grows at a positive and relatively steady rate for long periods of time 7.2 How does a Nation’s Economy Grow? A nation can increase its GDP by: o Increasing its stock of physical capital o Increasing the total efficiency units of labor o Improving its technology All resources households decide to save will be allocated to firms that will use them for investment Saving is a way of allocating some of today’s resources for consumption tomorrow Interest rate rate of return that households expect on their savings o Higher interest rate= more saving, lower= more consumption The saving rate designates the fraction of income that is saved o Saving rate= total saving/ GDP Because of diminishing marginal product of physical capital, more and more physical capital will translate into smaller and smaller increases in GDP Holding all factors of production and tech constant, every additional worker will increase GDP by less and less b/c diminishing marginal product If we increase the efficiency units of labor for a given work force, there will not be sustained growth b/c each worker has a finite life Technology is the only component that can sustain GDP growth Technological change is the process of new technologies and new goods and services being invented, introduced, and used in the economy, enabling the economy to achieve higher levels of GDP for given levels of physical capital stock and total efficiency units of labor o Technological change is exponential Improvements in technology need not necessarily run into diminishing marginal product > most plausible engine for sustained growth 7.3 The History of Growth and Technology The subsistence level is the minimum level of income per person that is generally necessary for the individual to obtain enough calories, shelter, and clothing to survive 2 reasons for lack of sustained growth before 1800 o Before 1800 technological growth was almost stagnant compared to today o Whatever improvements in aggregate incomes were realized did not typically translate into increases in income per capita Fertility refers to the number of children per adult or per woman of childbearing age Malthusian cycle refers to the preindustrial pattern in which increases in aggregate income lead to an expanding population, which in turn reduces income per capita and puts downward pressure on population Industrial Revolution is the term describing the series of innovations and their implementation in the production process that started to take place at the end of the eighteenth century in Britain 7.4 Growths, Inequality, and Poverty Even though this association does not prove that growth in income per capita is the direct cause of declining poverty, it is the type of evidence that bolsters many economists’ belief that economic growth is one of the most effective ways of reducing poverty
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