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# PowerPoints to accompany

C H AChapter
PTER

Macroeconomics

2
TOPIC 7 (Chapters 12-13)

## Technology, population growth

and the Solow model; ‘new’ vs
‘old’ economies; IT and growth;
technology & unemployment
C H AChapter
PTER 12
Technological
Progress and
Growth
12-1
Technological Progress
and the Rate of Growth

## ÎTechnological progress has many dimensions.

It may mean:
SLarger quantities of output
SBetter products
SNew products
SA larger variety of products
ÎTechnological progress leads to increases in
output for given amounts of capital and labour.

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 3
Technological Progress
and the Production Function

## ÎLet’s denote the state of technology by A and

rewrite the production function as
Y = F ( K , N , A)
(+ + +)
 A more restrictive but more convenient form is
Y = F ( K , AN )
 Output depends on both capital and labour,
and on the state of technology.

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 4
Technological Progress
and the Production Function

## ÎTechnological progress reduces the number of

workers needed to achieve a given amount of
output.
ÎTechnological progress increases AN, which we
can think of as the amount of effective labour,
or labour in “efficiency units.” in the economy.
ÎWith constant returns to scale,
2Y = F (2 K ,2 AN )
 More generally,
xY = F ( xK , xAN )

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 5
Technological Progress
and the Production Function

## ÎThe relation between output per effective

worker and capital per effective worker is:
Y ⎛ K ⎞
= F⎜ ,1⎟
AN ⎝ AN ⎠
which we can redefine as
Yt ⎛ Kt ⎞
= f⎜ ⎟
At N t ⎝ t t⎠
A N
In words, output per effective worker at time t is a
function of capital per effective worker.

## Note that the growth rate of ‘effective labour’ is gA+gN

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 6
Technological Progress
and the Production Function

Y/AN
Output per Effective
Worker Versus Capital
per Effective Worker
f(K/AN)
Because of decreasing
returns to capital,
increases in capital per
smaller and smaller
increases in output per
effective worker.

K/AN

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 7
Interactions Between
Output and Capital

## ÎThe dynamics of output and capital per worker

involve:
1. The relation between output per effective worker and
capital per effective worker.
I = S = sY
Dividing both sides by AN, we get
It ⎛ Yt ⎞
= s⎜ ⎟
At N t ⎝ At N t ⎠

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 8
Interactions Between
Output and Capital

##  The dynamics of output and capital per worker

involve:
2. The relation between investment per effective
worker and capital per effective worker.
Y ⎛ K ⎞ then I ⎛ K ⎞
Given that = f⎜ ⎟ = sf ⎜ ⎟
AN ⎝ AN ⎠ AN ⎝ AN ⎠

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 9
Interactions Between
Output and Capital
 The dynamics of output and capital per worker
involve:
3. The investment needed to maintain capital per effective worker
from depreciation and growth of effective workers.
δK + ( g A + g N ) K

or equivalently (δ + g A + gN )K
 The amount of investment per effective worker needed to
maintain a constant level of capital per effective worker is
K
(δ + g A + g N )
AN
© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 10
Dynamics of Capital and Output

Î At (K/AN)0, actual

Y/AN
gN )K/AN
investment exceeds the
investment level required
to maintain the existing f(K/AN)
level of capital per
effective worker, K/AN sf(K/AN)
increases.
Î In the long run, or in the
economy, capital per
effective worker and (K/AN)0 (K/AN)*
output per effective
K/AN
worker are constant and
equal to (K/AN)* and
(Y/AN)*.

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 11
Dynamics of Capital and Output

## ÎIn steady state, output (Y) grows at the same

rate as effective labour (AN); effective labour
grows at a rate (gA+gN); therefore, output
growth in steady state equals (gA+gN). Capital
also grows at a rate equal to (gA+gN).
ÎThe growth rate of output is independent of the
saving rate.
ÎBecause output, capital, and effective labour
all grow at the same rate, (gA+gN), the steady
state of the economy is also called a state of
balanced growth.
© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 12
Dynamics of Capital and Output

## Table 12-1 The Characteristics of Balanced Growth

Rate of growth of:
1 Capital per effective worker 0
2 Output per effective worker 0
3 Capital per worker gA
4 Output per worker gA
5 Labour gN
6 Capital gA + gN
7 Output gA + gN

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 13
The Effects of the Saving Rate

Y/AN
The Effects of an
Increase in the Saving f(K/AN)
Rate: I
gN )K/AN
An increase in the saving s1f(K/AN)
s0f(K/AN)
of output per effective
worker and capital per
effective worker.
(K/AN)0 (K/AN)1
K/AN

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 14
The Effects of the Saving Rate

The Effects of an
Increase in the Saving
Rate: II
The increase in the
higher output growth until
the economy reaches its
new, higher, balanced
growth path.

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 15
The effects of the higher depreciation,
technological progress or population growth

## Standard of living improves with higher gA , but

deteriorates with higher δ or gN . Why?

##  Fall in population growth in Africa (through AIDS, wars

etc) will lead to a a higher standard of living of survivors in
the long run! Why?
© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 16
12-2
The Determinants of
Technological Progress

## ÎTechnological progress in modern economies is the

result of firms’ research and development (R&D)
activities. The outcome of R&D is fundamentally ideas.
ÎAustralian firms appear to be lagging in R&D.
S Australia spends 1.5% of GDP on R&D (low compared to US,
France, UK, Germany & Japan)
S 30% of about 95,000 R&D personnel are employed by firms in
Australia. (In US, 75%of 1 million).
S Australian firms spend 11% of gross investment on R&D. (In
US, 20%).
ÎSpending on R&D depends on:
S The fertility of the research process, or how spending on R&D
translates into new ideas and new products, and
S The appropriability of research results, or the extent to which
firms benefit from the results of their own R&D.

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 17
The Fertility of the Research Process

## ÎThe determinants of fertility include:

S The interaction between basic research (the search
for general principles and results) and applied
research (the application of results to specific uses).
S The country: some countries are more successful at
basic research; others are more successful at
applied research and development.
S Time: It takes many years, and often many decades,
for the full potential of major discoveries to be
realized.

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 18
The Appropriability
of Research Results

## ÎIf firms cannot appropriate the profits from the

development of new products, they will not
engage in R&D. Factors at work include:
S The nature of the research process. Is there a
payoff in being first at developing a new product?
S Legal protection. Patents give a firm that has
discovered a new product the right to exclude
anyone else from the production or use of the new
product for a period of time.

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 19
12-3
The Facts of
Growth Revisited

## Capital Accumulation Versus Technological

Progress
ÎFast growth may come from two sources:
SA higher rate of technological progress, gA
SAdjustment of capital per effective worker, K/AN, to
a higher level.

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 20
Capital Accumulation Versus
Technological Progress

TABLE 12.2 AVERAGE ANNUAL GROWTH PER WORKER AND TECHNOLOGICAL PROGRESS IN FIVE
RICH COUNTRIES, 1950-2004

## 1950-1973 1974-2004 CHANGE 1950-1973 1974-2004 CHANGE

(1) (2) (3) (4) (5) (6)
Australia 2.3 1.5 -0.8 1.2 1.3 0.1
France 4.5 1.7 -2.8 4.0 1.3 -2.8
Japan 7.4 2.2 -5.2 6.9 1.3 -5.6
United Kingdom 2.5 1.8 -0.6 1.7 1.6 -0.1
United States 1.8 1.5 -0.4 1.9 1.1 -0.7
Average 3.7 1.7 -2.0 3.1 1.3 -1.8
"Average" is a simple average of the growth rates in each column. "Rate of technological progress" is weighted growth rates of labour
and capital subtracted from output growth, divided by a fixed labour share of .7. The data for Japan begins in 1955.

SOURCES: ABS, BEA, BLS, OECD, Angus Maddison"Dynamic Forces in Capitalist Development" (New York: Oxford University Press,
1991).

## Technological progress accounted for most growth

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 21
Capital Accumulation Versus
Technological Progress

## Î Table 12-2 illustrates three main facts:

1. The period of high growth of output per capita, from
1950 to 1973, was mostly due to rapid
technological progress, not to unusually high
capital accumulation.
2. Apart from Australia & UK, the slowdown in growth
of output per capita since 1973 has come mainly
from a decrease in the rate of technological growth,
not from unusually low capital accumulation.
3. Convergence of output per capita across countries
has come from higher technological progress rather
than from faster capital accumulation.
© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 22
12-4 Epilogue: The
Secrets of Growth

## ÎDifferences in output per worker between rich

and poor countries are mostly attributed to
differences in the measured level of technology
across countries. For various reasons, poor
countries are unable to close this technology
gap.
SReasons include political instability, poorly
established property rights, lack of entrepreneurs,
and poorly developed financial markets.

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 23
Epilogue: The Secrets of Growth

## ÎThe poor countries that have grown rapidly in

the last 20 years have experienced a rapid
accumulation of both physical and human
capital.
ÎThe contributions of both technological progress
and capital accumulation to growth depend on
the quality of institutions in a country.

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 24
Institutions Matter for Growth!

Good institutions:
- protection from expropriation
- judicial system resolves disputes quickly
- reliable patent laws
- credible anti-trust laws

GDP per
South Korea relied on a capitalist capita 14000
organization of the economy, with South Korea
12000
strong state intervention, but also

1996 US dollars
10000
private ownership and legal
8000
protection of private producers.
6000
North Korea relied on central
4000 North Korea
planning.
2000
Growth of GDP per capita was very
0
different! 1950 1960 1970 1980 1990 1998

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 25
Hong Kong, Singapore
Many similarities –
• Ex-British colonies, city-states, post-war S China immigrants
• Trading ports with similar industries, but Singapore lagged HK by a

Many differences -
• HK – minimal government intervention – provided infrastructure and land for
expansion
• SNG – much intervention - I/Y rose from 9% in 1960 to 43% in 1984; forced
saving, industrial policy using tax incentives
• gY/N 1970-90: HK = 2.4%, SNG = 1.5%
• gA : HK = 2.3%, SNG = 0.1%
Why the difference? Alwyn Young: SNG moved too fast from one industry to the
next – unbalanced growth! Too little gA. . SNG has since taken heed, and
has grown well since mid-1990s
© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 26
Institutions matter!
Comparing with China and Taiwan

planning and
communist institutions. 20000

SINGAPORE
HK, SNG and Taiwan HONG KONG
15000
chose the capitalist
TAIWAN
path with well-enforced 10000
property rights.
5000
China became CHINA

## relatively poorer from

0
1950, and now has a 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
lot of catching-up!
Î GDP PER CAPITA (PPP-ADJUSTED) 1950-2001
Î SOURCE: Angus Maddison, The World Economy:
Historical Statistics, OECD 2004

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 27
C H AChapter
PTER 13

Technological
Progress,
Wages,
and
Unemployment
Dimensions of Technological Progress

## QUESTION: Does technology improvement lead to

unemployment?
ANSWER: Higher unemployment can only occur in
short run, if at all. In medium run, unemployment
might even fall!

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 29
Dimensions of Technological Progress

## ÎTechnological progress allows more output from

the same number of workers
2 interpretations:
SOptimistic: More output with the same workers
SPessimistic: Same output with fewer workers

## ÎTechnological unemployment—a concept

associated with the technocracy movement during
the Great Depression and the Luddites in the 19th
century—is the argument that unemployment
comes from the introduction of machinery.

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 30
Dimensions of Technological Progress

## ÎTechnological progress leads to the production

of new goods and the disappearance of old
ones.
ÎThe process of growth is fundamentally a
process of creative destruction. With
technological progress comes a process of job
creation and job destruction.

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 31
Productivity, Output, and
13-1
Unemployment in the Short Run

## ÎA production function with technological

progress can be written as:
Y = F ( K , AN )
 Leaving aside matters concerning capital, then:
Y = AN
 Output is produced using only labour, N, and
each worker produces A units of output.
Increases in A represent technological progress.

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 32
Productivity, Output, and
Unemployment in the Short Run

Y = F ( K , AN ) = AN
ÎThen, employment is equal to output divided by
productivity, A.
Y
N=
A
 The concern is that, given output, an increase in
productivity decreases the level of employment.
This chapter explores this issue, in particular,
the short- and medium-run responses of output,
employment, and unemployment.

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 33
Technological Progress, Aggregate
Supply, and Aggregate Demand

## Aggregate Supply and

Aggregate Demand for
a Given Level of
Productivity
The aggregate supply
curve is upward sloping.
An increase in output
the price level. The
aggregate demand curve
is downward sloping. An
increase in the price level
output.

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 34
Technological Progress, Aggregate
Supply, and Aggregate Demand

## ÎThe impact of an increase in productivity on

output and employment in the short run
depends on how it affects the aggregate supply
and aggregate demand curves.
S Higher productivity decreases the amount of labour
needed to produce a unit of output, resulting in lower
cost and a lower price for a given output level. The
aggregate supply curve shifts down.

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 35
Technological Progress, Aggregate
Supply, and Aggregate Demand

## ÎThe effects of higher productivity on aggregate

demand in the short run depend on the source
of the productivity increase:
S Technological breakthroughs will bring prospects of
higher profits and a boom in investment. The
demand for goods rises— aggregate demand shifts
to the right.
S The more efficient use of existing technologies may
require little or no new investment. Worries about
job security will trigger more saving—the aggregate
demand curve shifts to the left.

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 36
Technological Progress, Aggregate
Supply, and Aggregate Demand

## The Effects of an Increase

in Productivity on Output in
the Short Run
An increase in productivity
shifts the aggregate supply
curve down. It has an
ambiguous effect on the
aggregate demand curve,
which may shift to the left or
to the right. In this figure, we
assume a shift to the right,
higher output in the short run.
(But effect is ambiguous)

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 37
Does technology improvement reduce the
natural rate of unemployment?

Wage
WageSetting:
Setting: W = A P F [ u,z ]
e e

## Ae = the expected level of productivity is incorporated

into wages set in bargaining.

W
Price
PriceSetting:
Setting: P = (1+ μ )
A
If A increases, W/A falls, which lowers P given W.

## NB With Y=AN, 1 unit of output is produced by 1/A workers.

So the cost of producing 1 unit of output = W (1/A) = W/A

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 38
Does technology improvement reduce the natural
rate of unemployment?

## In medium run, Ae = A & Pe = P.

W
= A F [ u,z ]
P
W
P = (1+ μ )
A
Therefore
1
F [ un , z ] =
1+ μ
So un is independent of A
© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 39
Summary: Technological progress
and unemployment

## u in the short run may be affected by the level or

rate of growth of productivity. It may go up or down

## However un in the medium and long run does not

depend on the level or rate of growth of
productivity

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 40
The Empirical Evidence:
Productivity growth and output growth
12
In Australia, there is a
10
positive relation between

## Annual rate of change (%)

8 Output growth
output growth and
6
productivity growth.
4
But be careful: 2
correlation is not the 0
same as causation -2
Productivity
-4
growth
-6
1965 1970 1975 1980 1985 1990 1995 2000 2005

## Research on the effects of exogenous movements in productivity growth on

output shows that:

## - Sometimes increases in productivity lead to increases in output

sufficient to maintain or even increase employment in the short run.

## - Sometimes they do not, and unemployment increases in the short run.

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 41
The Empirical Evidence:
The Medium Run
3.0
Productivity Growth
1951-1960
and Unemployment in

## Average annual labour productivity growth (%)

2.5
Australia—Averages
1990-1999
1970-1979
There is little relation 1.5
between the 10-year 1940-1949
2000-05
averages of productivity 1.0 1920-1929
1901-1909
1980-1989
growth and the 10-year
0.5 1930-1939
averages of the
unemployment rate. If
0.0
anything, higher 1910-1919
productivity growth is -0.5
associated with lower 0 2 4 6 8 10 12 14

## unemployment, in the Average unemployment rate (%)

medium run.

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 42
Why did Australia do so well from
the 2nd half of the 1990s?

## TABLE 1 SELECTED AUSTRALIAN MACROECONOMIC VARIABLES

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
GDP growth 3.5 4.2 3.9 4.9 4.3 3.3 2.2 4.0 3.0 3.5 2.4
Unemployment rate 8.1 8.0 8.2 7.9 6.7 6.2 6.9 6.5 6.2 5.6 5.0
Inflation rate 1.8 2.1 1.3 0.5 0.5 4.1 4.0 2.6 0.9 0.9 0.7
Labour productivity growth 0.6 3.3 3.0 2.9 3.9 1.3 0.3 2.6 1.4 1.9 -0.6

## Labour productivity surged leading to high Y growth, falling u and low

inflation. Why?
• A series of microeconomic reforms from 1980s onwards
• Australia had a very high uptake of new ICT technologies
• However real wages have not kept pace with labour productivity growth,
implying that profits have benefitted!

© 2007 Pearson Education Macroeconomics, 2nd edition Olivier Blanchard & Jeffrey Sheen 43