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Economic Growth

Growth Basics

Production

**ECON 2102: Lecture 1
**

Christopher Gibbs

UNSW Australia

1

Introductions

Economic Growth

Growth Basics

Production

Welcome

Introductions

**• Lecturer-in-charge: Christopher Gibbs... that’s me
**

• Consultation Times: Wednesday 14:00 - 16:00

• Office: QUAD 3120

• Email: christopher.gibbs@unsw.edu.au

2

Introductions

Economic Growth

Growth Basics

Production

Class Outline

Introductions

•

Lecture

•

Tutorials

•

Journal

3

..Me talking. • Tutorials • Journal 4 . lots of examples and bad jokes...Introductions Economic Growth Growth Basics Production Class Outline Introductions • Lecture . you listening.

you listening... • Journal 5 . • Tutorials ..Me talking. lots of examples and bad jokes..Engagement with the material through outside reading and group problem sets.Introductions Economic Growth Growth Basics Production Class Outline Introductions • Lecture .

lots of examples and bad jokes. Will be assessed and very useful for studying for the exams..Introductions Economic Growth Growth Basics Production Class Outline Introductions • Lecture .Engagements with the material through outside reading and group problems.Your record of everything you have done in the course. • Journal .. 6 .Me talking. you listening. • Tutorials ...

Introductions Economic Growth Growth Basics Production Journal What goes in the Journal? Introductions 7 .

7 .Introductions Economic Growth Growth Basics Production Journal What goes in the Journal? Introductions • Notes on assigned reading and outside material.

How many assigned readings are there? 15. . 7 .Introductions Economic Growth Growth Basics Production Journal What goes in the Journal? Introductions • Notes on assigned reading and outside material.. check the course outline for full details..

• Tutorial problem attempts and notes 7 .REQUIREMENT: If reading is longer than 1 page of text. then 1 reading/activity = 1 page of notes (may be in outline form).. . . but must be more than one sentence. If shorter than 1 page. then notes may be less than one page..How many assigned readings are there? 15. check the course outline for full details.Introductions Economic Growth Growth Basics Production Journal What goes in the Journal? Introductions • Notes on assigned reading and outside material.

.REQUIREMENT: If reading is longer than 1 page of text. 7 .. . then notes may be less than one page. but must be more than one sentence. If shorter than 1 page. check the course outline for full details.How many assigned readings are there? 15. Record your work in your journal. • Tutorial problem attempts and notes .Introductions Economic Growth Growth Basics Production Journal What goes in the Journal? Introductions • Notes on assigned reading and outside material.Most tutorial will have a small group problem set. then 1 reading/activity = 1 page of notes (may be in outline form)..

• Tutorial problem attempts and notes .REQUIREMENT: If reading is longer than 1 page of text.. . then notes may be less than one page.Most tutorial will have a small group problem set.Introductions Economic Growth Growth Basics Production Journal What goes in the Journal? Introductions • Notes on assigned reading and outside material.How many assigned readings are there? 15.. but must be more than one sentence. check the course outline for full details. . Record your work in your journal. • Take-home assignments 7 . then 1 reading/activity = 1 page of notes (may be in outline form). If shorter than 1 page.

.REQUIREMENT: If reading is longer than 1 page of text.There are FOUR assignments in the course and you must record your work in the journals. Record your work in your journal.Most tutorial will have a small group problem set. then notes may be less than one page.Introductions Economic Growth Growth Basics Production Journal What goes in the Journal? Introductions • Notes on assigned reading and outside material. 7 . check the course outline for full details. • Tutorial problem attempts and notes . then 1 reading/activity = 1 page of notes (may be in outline form). If shorter than 1 page.How many assigned readings are there? 15... but must be more than one sentence. . • Take-home assignments .

Introductions Economic Growth Growth Basics Production Journal How is the journal marked? Introductions 8 .

Spot checks will be conducted periodically during tutorials. Introductions 8 .Completed journals due in week 12.Introductions Economic Growth Growth Basics Production Journal How is the journal marked? . The journals will be marked for completeness and accuracy on selected parts. They will be returned week 13 in order to be used as study guides. . Tutors will check to see if the required reading’s notes are in the journal and whether the assignment has been attempted.

Introductions Introductions Economic Growth Growth Basics Production Let’s Start 9 .

Introductions Economic Growth Growth Basics Production A Brief Introduction to Mathematical Notation Introductions • This course uses mathematics to describes the economy. but the notation can be confusing. • We start with a quick overview of the notation we will use throughout the course. 10 . mostly just basic algebra. The math is not in general hard.

GDP.Y = real output. income (dollars) - - C = Consumption I = Investment G = Government spending T = taxes Nx = Net Exports K = capital L = labor A = technology. productivity. ideas P = price level π = inflation rate (percent) R = nominal rental rate of capital r = real interest rate i = nominal interest rate 11 .Introductions Economic Growth Growth Basics Production A Brief Introduction to Mathematical Notation Introductions • Common variable names: .

L The above expresses capital in per capita or per worker terms. For example.Introductions Economic Growth Growth Basics Production A Brief Introduction to Mathematical Notation Introductions • Common variable changes: . . if I want to hold capital constant in my analysis I write K¯ 12 .Lower versus upper case: when a variable is changed from upper case to lower case it is usually because of a definition change such as k= K .Variables that do not change or are held constant during analysis are given a bar.

. 13 .Introductions Economic Growth Growth Basics Production A Brief Introduction to Mathematical Notation Introductions • Dynamic versus static analysis: . .Future are thus given by Yt+i where i = 1.. . . ∞ and the past is represented by Yt−i . When we wish to take time into account we make use of time subscripts Yt where t denotes current period.Dynamic analysis takes time into account.

• Therefore.Introductions Economic Growth Growth Basics Production A Brief Introduction to Mathematical Notation Introductions • Dynamic analysis allows you to explore how the economy transitions between equilibria or around an equilibrium of interest. 14 . • Any static model we introduce can be made dynamic and any dynamic model can be made static. whether we study a dynamic or static version of model will depend on the specific question of interest. • Static models allow you to compare one equilibrium to another.

Most macroeconomic models consists of two components: 1 Behavioral equations 2 An equilibrium condition 15 .Introductions Economic Growth Growth Basics Production A Brief Introduction to Mathematical Notation Introductions • Equilibrium and solving a model .

provides a rule for the people of the economy to follow.Introductions Economic Growth Growth Basics Production A Brief Introduction to Mathematical Notation Introductions • Equilibrium and solving a model .Most macroeconomic models consists of two components: 1 Behavioral equations . 2 An equilibrium condition 16 .

Most macroeconomic models consists of two components: 1 Behavioral equations .Introductions Economic Growth Growth Basics Production A Brief Introduction to Mathematical Notation Introductions • Equilibrium and solving a model . 2 An equilibrium condition . 17 .provides a constraint that bounds the actions of the people following the rules.provides a rule for the people of the economy to follow.

Therefore.Introductions Economic Growth Growth Basics Production A Brief Introduction to Mathematical Notation Introductions • Equilibrium and solving a model .provides a rule for the people of the economy to follow. 2 An equilibrium condition .Most macroeconomic models consists of two components: 1 Behavioral equations .provides a constraint that bounds the actions of the people following the rules. 18 . solving the model is finding the actions of the people in the economy that satisfy a given equilibrium condition. .

Introductions Economic Growth Growth Basics Production A Brief Introduction to Mathematical Notation Introductions • Equilibrium and solving a model: Econ 101 Example (The Keynesian Cross) .Behavioral Equations: C = I = G = T = C0 + C1 (Y − T ) I¯ G¯ T¯ .Equilibrium Condition: Y =C +I +G 19 .

output Y and consumption C are endogenous. G . . and taxes (T ). Because their values are not predetermined but depend on the choice of investment (I ).Solving this model is simply a matter of finding an equation for the endogenous variables in terms of the exogenous variables.I . which are held constant in this simple case.In this case. .Introductions Economic Growth Growth Basics Production A Brief Introduction to Mathematical Notation Introductions • Equilibrium and solving a model: Econ 101 Example (The Keynesian Cross) . and T are therefore exogenous.Why?. government spending (G ).. . 20 ..

To solve Y = C +I +G Y = Y − C1 Y = Y = C0 + C1 (Y − T¯ ) + I¯ + G¯ C0 − C1 T¯ + I¯ + G¯ 1 C0 − C1 T¯ + I¯ + G¯ 1 − C1 21 .Introductions Economic Growth Growth Basics Production A Brief Introduction to Mathematical Notation Introductions • Equilibrium and solving a model: Econ 101 Example (The Keynesian Cross) .

To solve Y = C +I +G Y = Y − C1 Y = Y = C0 + C1 (Y − T¯ ) + I¯ + G¯ C0 − C1 T¯ + I¯ + G¯ 1 C0 − C1 T¯ + I¯ + G¯ 1 − C1 .Introductions Economic Growth Growth Basics Production A Brief Introduction to Mathematical Notation Introductions • Equilibrium and solving a model: Econ 101 Example (The Keynesian Cross) .Y is written as a function of exogenous stuff. 21 .

What are C0 and C1 ? Introductions 22 .Introductions Economic Growth Growth Basics Production A Brief Introduction to Mathematical Notation • Equilibrium and solving a model: Econ 101 Example (The Keynesian Cross) .

Something in the model must remained fixed in response to policy.What are C0 and C1 ? .They are exogenous and treated differently from things like G and T because they are not generally thought of as parts of the model that can be made endogenous.Introductions Economic Growth Growth Basics Production A Brief Introduction to Mathematical Notation • Equilibrium and solving a model: Econ 101 Example (The Keynesian Cross) . The choice of what is endogenous to policy changes is very important in economics. .These are called parameters of the model. Introductions 22 .

Economic Growth Introductions Economic Growth Growth Basics Production Topic 1: Economic Growth 23 .

Economic Growth Introductions Economic Growth Growth Basics Production The questions of interest: 24 .

Introductions Economic Growth Growth Basics Production The questions of interest: Why are some countries rich and others poor? Economic Growth 24 .

Introductions Economic Growth Growth Basics Production The questions of interest: Why are some countries rich and others poor? How can poor countries become rich? Economic Growth 24 .

Introductions Economic Growth Growth Basics Production Economic Growth Economic Growth Figure: Source: Maddison (2008) 25 .

Dollars) 40.Introductions Economic Growth Growth Basics Production Economic Growth Economic Growth Constant GDP per capita for the United States Constant GDP per capita for China Constant GDP per capita for the World Constant GDP per capita for Australia Constant GDP per capita for the Republic of Korea 50.000 30.org Figure: Source: FRED 26 .000 20.000 0 1960 1970 1980 1990 2000 2010 research.stlouisfed.000 (2005 U.S.000 10.

what is it about the “nature of India” that makes this so? The consequences for human welfare involved in questions like these are simply staggering: Once one starts to thing about them. Lucas.E.R. Is there some action a government of India could take that would lead to the Indian economy to grow like Indonesia’s or Egypt’s? If so. Nobel Prize Winner 1995 Economic Growth 27 . what exactly? If not.” . it is hard to think about anything else.Introductions Economic Growth Growth Basics Production Economic Growth I do not see how one can look at figures like these without seeing them as representing possibilities.

Introductions Economic Growth Growth Basics Production Economic Growth Economic Growth A simple model of economic growth 28 .

yt+1 = yt (1 + g ) (2) .Introductions Economic Growth Growth Basics Production Growth Basics The basic tools for studying growth: Growth Basics • The Growth Rate g= yt+1 − yt yt (1) where yt stands for per capita income. 29 .This representation is useful because it allows us to determine the value of per capita income tomorrow if we known the value today.

Introductions

Economic Growth

Growth Basics

Production

Growth Basics

To see why yt+1 = yt (1 + g ) is useful, consider the following example:

Growth Basics

• Recalling the West and Rest graph in the previous slides, per capita

**income throughout the world was around $600 in the year 1500.
**

However, by the year 2000 it was y2000 = 39, 000 for the West and

y2000 = 9, 000 for the Rest. What was the difference in the growth

rates over time to generate the divergence?

30

Introductions

Economic Growth

Growth Basics

Production

Growth Basics

yt+1 = yt (1 + g )

Growth Basics

(3)

31

Introductions

Economic Growth

Growth Basics

Production

Growth Basics

yt+1 = yt (1 + g )

(3)

y1 = y0 (1 + g )

(4)

y2 = y1 (1 + g )

(5)

Which implies

Growth Basics

31

Growth Basics 31 .Introductions Economic Growth Growth Basics Production Growth Basics yt+1 = yt (1 + g ) (3) y1 = y0 (1 + g ) (4) y2 = y1 (1 + g ) (5) y2 = y0 (1 + g )(1 + g ) = yo (1 + g )2 (6) Which implies Therefore.

using this equation we can solve for the growth rates of the West and the Rest Growth Basics 32 .Introductions Economic Growth Growth Basics Production Growth Basics yt = y0 (1 + g )t (7) Now.

using this equation we can solve for the growth rates of the West and the Rest g= Growth Basics yt y0 1t −1 32 .Introductions Economic Growth Growth Basics Production Growth Basics yt = y0 (1 + g )t (7) Now.

000 = 600(1 + g )500 and Rest: 9.00543 Perhaps surprisingly. small changes in the growth rate actually imply huge differences over long periods of time.Introductions Economic Growth Growth Basics Production Growth Basics West: 39.00838 and Rest: 9000 600 1 500 = 0. 000 = 600(1 + g )500 West: 39000 600 1 500 = 0. Growth Basics 33 .

Introductions Economic Growth Growth Basics Production Growth Basics You can also achieve an approximation using logs ln(yt ) = ln(y0 (1 + g )t ) ln(yt ) = ln(y0 ) + ln((1 + g )t ) ln(yt ) = ln(y0 ) + t ∗ ln(1 + g ) ln(yt ) − ln(y0 ) = ln(1 + g ) ≈ g t Logs are very useful when working with growth rates. Growth Basics 34 .

you get nearly identical results as long as g is small.Introductions Economic Growth Growth Basics Production Growth Basics West: 39. 000 = 600(1 + g )500 and Rest: 9.005 500 See. 000 = 600(1 + g )500 West: ln(39000) − ln(600) ≈ 0. Growth Basics 35 .008 500 and Rest: ln(9000) − ln(600) ≈ 0.

just divide 70 by the growth rate. • To see why consider 2y0 2 ln(2) ln(2) ln(1 + g ) = y0 (1 + g )t = (1 + g )t = t ∗ ln(1 + g ) 0.7 ≈ ≈t g 36 .Introductions Economic Growth Growth Basics Production Growth Basics yt+1 = yt (1 + g ) is useful because of the rule of 70 Growth Basics • If you want to know how long it takes for a value to double using growth rates.

Introductions Economic Growth Growth Basics Production Growth Basics Now. it is also the case that growth rates are rarely constant over time. Because of this fact. Log Scale Growth Basics Ratio Scale 37 . it is often useful to consider variables on a log or ratio scale.

38 . then gz = gx + gy 3 if z = x a .Introductions Economic Growth Growth Basics Production Growth Basics Growth Basics • Some Useful Properties of Growth Rates 1 if z = x/y . then gz = a × gx .Note that most of these properties stem from the properties of logarithms. then gz = gx − gy 2 if z = x × y .

5% and Nt is growing at 3%. If Kt is growth at 3.Introductions Economic Growth Growth Basics Production Growth Basics • Suppose Kt is stock of capital in the economy and Nt is the population. how fast is capital per worker growing? Growth Basics 39 .

5% and Nt is growing at 3%.capital per worker implies kt = Kt /Nt .5% Growth Basics 39 . which using rule 1 yields gk = gK − gN = 0. how fast is capital per worker growing? . If Kt is growth at 3.Introductions Economic Growth Growth Basics Production Growth Basics • Suppose Kt is stock of capital in the economy and Nt is the population.

What does this relationship say about inflation? Growth Basics 39 . how fast is capital per worker growing? . If Kt is growth at 3.5% and Nt is growing at 3%.capital per worker implies kt = Kt /Nt .Introductions Economic Growth Growth Basics Production Growth Basics • Suppose Kt is stock of capital in the economy and Nt is the population. which using rule 1 yields gk = gK − gN = 0.5% • Consider the quantity theory of money MV = PY .

5% • Consider the quantity theory of money MV = PY . which using rule 1 yields gk = gK − gN = 0.5% and Nt is growing at 3%.Well π = gP . therefore Growth Basics gM + gV = π + gY π = gM + gV − gY 39 .Introductions Economic Growth Growth Basics Production Growth Basics • Suppose Kt is stock of capital in the economy and Nt is the population. What does this relationship say about inflation? .capital per worker implies kt = Kt /Nt . If Kt is growth at 3. how fast is capital per worker growing? .

. “All models are wrong. we begin our study of growth with a simple model of production. but some are useful.Therefore.” 40 . we can define growth as the change in production per worker.In fact. .Introductions Economic Growth Growth Basics Production A Simple Model of Production Production • Economic growth is all about production.

I say let’s just call it a widget and denote it as Y .Labour • Capital and Labour come together to form a widget using the following function: 1 2 Y = F (K . The book says ice cream. L) = AK 3 L 3 (8) Where A is a productivity parameter or proxy for technology.Introductions Economic Growth Growth Basics Production A Simple Model of Production Production • Suppose we live in a world where only one good is produced. Widgets are produced using two inputs: 1 K . 41 .Capital 2 L . This is known as the Cobb-Douglas production function.

. L) = AK 3 L 3 (9) • The exponents on K and L are not arbitrary.Recall that perfect competition assumes price taking behavior by firms. To see this we need to think about the implications of this production function under perfect competition.Introductions Economic Growth Growth Basics Production A Simple Model of Production Production 1 2 Y = F (K . MC = MR 42 .

L) − WL − RK K . L) − w = 0 43 .Introductions Economic Growth Growth Basics Production A Simple Model of Production max Π = PF (K .L (10) where w is the wage and r is the rental rate. L) − r = 0 L : PFL (K .O. F.C: Production K : PFK (K .

L) = MPL = FL (K . F. L) − r = 0 L : PFL (K . L) − w = 0 MPK = FK (K .C: Production K : PFK (K . L) = R P W P (11) (12) 43 . L) − WL − RK K .O.Introductions Economic Growth Growth Basics Production A Simple Model of Production max Π = PF (K .L (10) where w is the wage and r is the rental rate.

L) 1 A 3 K L 2/3 = K L 1/3 = 2 A 3 And finally noting that A(L/K )2/3 = Y /K and A(K /L)1/3 = L/K Y = 1/3 Y Y K + 2/3 L K L (13) 44 . Then assuming Cobb-Douglas Production FK (K . L)L. it is straightforward to show that it must be the case that Y = FK (K .Introductions Economic Growth Growth Basics Production A Simple Model of Production Production Now. L)K + FL (K . L) FL (K .

Introductions Economic Growth Growth Basics Production A Simple Model of Production Production Figure: Source: OECD 45 .

Introductions Economic Growth Growth Basics Production A Simple Model of Production Production • Properties of the Cobb-Douglas Production: 1 Constant income shares.e. if one is held constant. 2L) 3 = A(2K )1/3 (2L)2/3 = A21/3 22/3 K 1/3 L2/3 = A2K 1/3 L2/3 Decreasing returns to scale in K and L i. 46 . F (2K . what we just saw.. then increasing the other increases production at a decreasing rate. 2 Constant returns to scale..

Partial Equilibrium . 5. Y = AK 1/3 L2/3 R Y = 3K P 2Y W = 3L P ¯ K =K L = L¯ 47 . .the equilibrium clears multiple markets. 3.the equilibrium clears a single market. 4.Introductions Economic Growth Growth Basics Production A Simple Model of Production Production • Equilibrium .General Equilibrium . • 5 equations and 5 Unknowns: 1. 2.

Introductions Economic Growth Growth Basics Production A Simple Model of Production Production The Factor Market Graphs (Done in lecture) 48 .

Therefore. tractors.Note this is not straightforward and is subject to many criticism dating back to the 1960s. .Introductions Economic Growth Growth Basics Production A Simple Model of Production Production The Empirical Fit of the Model • Development Accounting .. factories.The plan is to match up the pieces of the model with real world quantities. computers.. ..Take the model to the data and see how much it can explain.. we use an aggregate measure of K composed of the stock of housing. divided by working population. The Capital Controversies 49 ..

Introductions Economic Growth Growth Basics Production A Simple Model of Production Production The Empirical Fit of the Model • Let’s start with GDP per capita y∗ = Y∗ L∗ where the ∗ denote equilibrium quantities. • We can write this as y∗ Y∗ L∗ A¯K¯ 1/3 L¯2/3 = L¯ 1/3 ¯ ¯ = Ak = 50 .

182 0. which implies that all countries are equally productive.269 1.000 1.760 0.061 0.528 0.926 0.828 0. Switzerland Japan Italy Spain United Kingdom Brazil South Africa China India Burundi k per worker 1.944 0.178 0.Introductions Economic Growth Growth Basics Production A Simple Model of Production Production The Empirical Fit of the Model • Let’s assume that A¯ = 1.559 0.084 0.180 Actual y 1.686 0.010 Pred.S.006 Predicted y 1. Error 0% -12% -39% -42% -43% -6% -178% -200% -207% -369% -1700% Table: Source: Jones (2013) and my calculations 51 .000 0.147 0.966 0.975 0.546 0.174 0.083 1.394 0.162 0.172 0.056 0.876 0.201 0. Country U.840 0.661 0.000 1.671 0.

we need to consider the A¯ term. at least with respect to the simple model. . 52 .The model appears to systematically over predict income given the amount of capital that exists.Therefore.Introductions Economic Growth Growth Basics Production A Simple Model of Production Production The Empirical Fit of the Model • Model Performance . .A¯ may not be constant across countries.

.An important limitation of this approach is that we do not have good measures of efficiency.In our simple model. . 53 . placing a A¯ < 1 on the countries in the previous table can bring the model predictions into line. TFP is really just a measure of the unobservable difference between the model prediction and reality and could have many different components.TFP is often referred to as a residual. Therefore. . which you may recall from econometrics is the model error. .TFP can be thought of as how efficiently a countries uses capital and labour to produce output.Introductions Economic Growth Growth Basics Production A Simple Model of Production Production ¯ What is A? • The A¯ term is called total factor productivity (TFP).

This gap of nearly 9 years can explain half of TFP differences.The average number of years an adult spends in school in the US and Australis is just under 13. . 54 . .Example: .Introductions Economic Growth Growth Basics Production A Simple Model of Production Production What can explain TFP differences? 1 Human Capital . .The average in the poorest countries is just 4 years. Indeed countries with higher educations levels have higher TFP.The model does not capture the resources and expertise brought by people to the production process. .We believe that human capital may explain a large portion of the difference.

laws. 3 Institutions . and levels of corruption actually may be the best explanation for difference in per capita GDP.Introductions Economic Growth Growth Basics Production A Simple Model of Production Production What can explain TFP differences? 2 Technology .Rich countries also enjoy much better infrastructure overall.Rich countries with higher TFP typically employ the latest technologies. . 55 .Perhaps the most important aspect of growth is the rules of the game. .Different government structures.

Introductions Economic Growth Growth Basics Production A Simple Model of Production Production 56 .

Introductions Economic Growth Growth Basics Production A Simple Model of Production Production Figure: Source: Papaioannou and Siourounis (2008) 57 .

where the market is only big enough to support a few large companies.This can also be a problem in small countries like Australia. . 58 . .Introductions Economic Growth Growth Basics Production A Simple Model of Production Production What can explain TFP differences? 4 Misallocation . .Uncompetitive market prevent the proper allocation of capital among firms.These large companies act like monopolies and restrict supply and charge higher prices.Another side of the institutions coin.

This implies differences in output per capita across countries cannot be explained well by capital alone. 3 There is a lot the model does not capture.Introductions Economic Growth Growth Basics Production A Simple Model of Production Production • What does the simple model of production teach us? 1 Per capita GDP will be higher in countries that have more capital per person and use it more efficiently. 59 . 2 Diminishing returns to capital are quite strong given the 13 exponent on K . In order to fit the data a lot of the variation must be pushed into the A term.

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