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Inourfirststepwetakethetotalamountofsavingsavailableforfirms
toinvestandlookathowtheybreakitup.Thefirstpriorityofthefirmisto
replacedepreciatedcapitalinordertomaintainaconstantlevelofworker
productivity.Consideraconstructionfirm.Assumeeachcarpenterhashisor
herownhammer.SidandNancycanbothinstall12nailsaminuteonagood
day.Nowassumethatoneofthetwohammersbreaks,andtheyhavetoshare
theremainingone.Workerproductivitywillplummet.Thefirstpriorityofthe
bossistoreplacethebrokenhammertomaintainworkerproductivityatits
previouslevel.
Nowletstakethecasewherethebossgiveseachworkeranewturbonailgun
asaChristmasbonus.Thesmartbossrealizesthathiscapitalinvestmenthas
alsoboostedworkerproductivityandbothSidandNancycannowinstall25
nailsperminute.Thus,netadditionstothecapitalstockraisesworker
productivityandcorrelatestotherateofeconomicgrowth.Increasesinthe
savingsratewillincreasetherateofcapitalaccumulationandalsothe
rateofeconomicgrowth.
Inourfirstlayerofourgrowthmodel,therateofeconomicgrowthis
determinedbytherateofnetinvestment.Ifthereisa1%netincreaseinthe
capitalstockeachyear,theneconomicgrowthalsoequals1%.Oursecond
layerofthemodelinvolvestherelaxationofourassumptionthatlaborforce
growthequalszero(#1above).Nowweallowforapositiveleveloflabor
forcegrowth.
Economic growth now is equal to the growth rate in our capital
stock plus the labor force growth rate, still holding technology
constant (#3 above).
Step 2: Net investment equals total savings minus the savings necessary to

replace the part of the capital stock that has depreciated plus the capital
needed to equip new workers entering the labor force.
The rate of economic growth equals the rate of net additions to the capital
stock and the labor force (or population) growth rate. Growth results
from increases in worker productivity and increases in the total number
of workers.

Herewegainadditionalrealisminourgrowthmodel.Therateofeconomic
growthisequaltotherateofincreaseinourcountry'scapitalstockplusthe
laborforcegrowthrate.However,allowingforthelaborforcetogrowisnota
simpleboosttogrowth.Inorderfornewworkerstobeasefficientastheir
counterparts,theyrequirecomparablecapitaltoworkwith.Imaginean
engineeringfirmthathandstheirnewemployeeasliderule,whileallofhisor
hercoworkershavehighpoweredcomputerstoworkwith.Thenewemployee
willlagseriouslyinproductivity.Thusweassumethatfirmsgivethenew
workerstheyhirethesamecapitaltoworkwithasexistingworkers,inorder
tomaintainaconstantlevelofworkerproductivityoroutputperworker.
Equippingnewworkerswithcapitaldivertssomesavingsawayfrom
undertakingnetinvestment.Inthiscase,netadditionstothecapitalstock
equalstheportionoftotalsavingsthatisnotusedtooffsetdepreciationand
equipnewworkerswiththeirshareofcapital.
Finally,weaddourfinallayerofrealismtothemodelbyallowingfor
improvementsintechnology.
Economic growth now is equal to the growth rate in the capital
stock plus the labor force growth rate plus the rate of change in
technology.

Technologicalimprovementsaddtoeconomicgrowthinthesamewaythat
increasesinthecapitalstockdo:byincreasingworkerproductivity.Byhaving
bettercapitalequipmenttouse,workerscanproducemoreperhourorday.
Considerhowtherapidevolutionofthepersonalcomputerhascontributedto
ourproductivity.Animportantconsiderationforaneconomytoreapthe
benefitsofimprovedtechnologyisthatthetechnologymustbeused.Ifyou
areusinga1986vintagePC,thenyouarenottakingadvantageofthe
tremendousgainsincomputerspeedofferedbythePentium.Asaresult,part
ofacountry'stotalsavingmustalsobedevotedtoupdatingitscapitalstock.
Step 3: Net investment equals total savings minus the savings necessary to
replace the part of the capital stock that has depreciated plus the savings

devoted to equipping new workers entering the labor force with their
share of capital, and the savings that must be devoted to updating the
capital stock to take advantage of improvements in technology.
The rate of economic growth equals the rate of net additions to the capital
stock, the labor force (or population) growth rate plus the rate of
technological advancement. Growth results from increases in worker
productivity and increases in the total number of workers.