Chapter 3. An Overview of Long-Run Economic Growth

An Overview of Long-Run Economic
Growth
— Week 3 —
Vivaldo Mendes
Dep. of Economics — Instituto Universitário de Lisboa
1 October 2019
(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 1 / 36

Summary
1 Growth over the Very Long Run

2 Modern Economic Growth
3 Modern Growth around the World
4 Some Useful Properties of Growth Rates
5 The Costs of Economic Growth
6 Required reading

I –Growth over the Very Long Run

Growth over the Very Long Run
The Great Divergence
1 Sustained increases in standards of living are a recent phenomenon.

2 The Great Divergence
1 The recent era of increased di¤erence in standards of living across
countries.
3 Before 1700
1 Per capita GPD in nations di¤ered only by a factor of two or three.
4 Today
1 Per capita GPD di¤ers by a factor of 50 for several countries.

Graph of the Great Divergence

II –Modern Economic Growth

Modern Economic Growth
The amazing improvement in living standards
1 From 1870 to 2000, United States per capita GDP ...

1 ... rose by nearly 15-fold.
2 Implications for you?
1 A typical college student today will earn a lifetime income about twice
his or her parents.
3 See next …gure.

Per capita GDP in the United States

The De…nition of Economic Growth
1 Growth of per capita GDP

2 Percentage change in GDP between period t and and t 1
yt yt 1
g=
yt 1
3 Or
y1 = y0 (1 + g)1
...
yt = y0 (1 + g)t

The Rule of 70 and the Ratio Scale
1 If y grows at a rate of g percent per year, then the number of years it

takes y to double is approximately equal to
70
g
2 Small di¤erences in growth rates result in large di¤erences over time.
3 The time it takes to double only depends on the growth rate and not
the initial value.
4 A ratio scale
1 Its like a logarithm scale
2 When plotted on a ratio scale, a variable that grows at a constant rate
will be a straight line

The absolute vsersus ratio scale

GDP has been rising since the 1880’s

Calculating Growth Rates
1 The rule for computing

growth rates
2 This formula can be
applied even if the data solve for
does not exhibit constant
growth. growth rate
1 In this case we get an
average annual
growth rate

III –Modern Growth around the World

Modern Growth around the World
Real Economic Convergence
1 After World War II, growth in Germany and Japan accelerated.

2 Convergence (real):
1 Poorer countries will grow faster to “catch up” to the level of income
in richer countries.
3 Brazil had accelerated growth until 1980 and then stagnated.
4 China and India have had the reverse pattern.

Real convergence in a ratio scale

Convergence: A Broad Sample of Countries
1 Over the period 1960–2007

1 Some countries have exhibited a negative growth rate.
2 Other countries have sustained nearly 6 percent growth
3 Most countries have sustained about 2 percent growth.
2 Small di¤erences in growth rates result in large di¤erences in
standards of living.

The lack of convergence

IV –Some Useful Properties of Growth

Rates

Some Useful Properties of Growth Rates
Real Economic Convergence
1 Growth rates of ratios, products, and powers follow several simple

rules.
2 Growth rates obey mathematical operations that are a level simpler
than the operation on the original variable.
1 Variables divided growth rates subtracted
2 Variables multiplied growth rates added
3 Variable taken to a power number growth rate multiplied by that
number

Transforming functions into log-di¤erences:

summary
Variables in levels Variables in ∆logs
yt = 2xt , gy = gx
yt = 2xt zt , gy = gx + gz
3
yt = 2xt zt , gy = gx 3gz
xt zt
yt + 1 = xt + 1 + zt + 1 , gy = gx + gz
yt yt
xt
yt + 1 = xt + 1 + a , gy = gx
yt

An example

Growth Rules in a Famous Example
1 Original output equation
Yt = At Kt1/3 L2/3
t
2 In terms of growth rates we have
gY = gA + (1/3)gK + (2/3)gL

Growth Rules in a Famous Example

V –The Costs of Economic Growth

The Costs of Economic Growth
The bene…ts of economic growth
1 Improvements in health
2 Higher incomes
3 Increase in the variety of goods and services

The Costs of economic growth
1 Environmental problems
2 Income inequality across and within countries
3 Loss of certain types of jobs
4 Economists generally have a consensus that the bene…ts of economic
growth outweigh the costs.

VI –Required readings

Required reading
For this week you are required to read Read Chapter 3 of our adopted
textbook.
Charles I. Jones (2014). Macroeconomics, Third Edition, W. W.
Norton & Company.

Appendix
How to transform functions in levels into
log di¤erences
The knowledge of this appendix is not compulsory. This is just used as a
proof of the results above.

Transforming functions into log-di¤erences: …rst

case
1 A linear function: Yt = 2Xt . Apply logs to two consecutive periods:
ln Yt = ln 2 + ln Xt
ln Yt+1 = ln 2 + ln Xt+1
2 Therefore, the …rst di¤erence of logs is
ln Yt+1 ln Yt = (ln 2 + ln Xt+1 ) (ln 2 + ln Xt ) = ln Xt+1 ln Xt

| {z } | {z }
growth rate of Y: gY growth rate of X: gX
3 In this kind of function, the growth rate of Y, let’s call it ( gY ), is

equal to the growth rate of X, (gX )
gY = gX

Transforming functions into log-di¤erences: second

case
1 A linear function of two independent variables: Yt = 2Xt Zt .

2 Apply logs to two consecutive periods, and you will get
gY = gX + gZ
3 Prove this result yourself.

Transforming functions into log-di¤erences: third

case
1 A power function: Yt = 2Xt Zt 3 .
2 Apply logs
ln Yt = ln 2 + ln Xt 3 ln Zt
ln Yt+1 = ln 2 + ln Xt+1 3 ln Zt+1
3 Therefore, the …rst di¤erence of logs is
ln Yt+1 ln Yt = (ln 2 + ln Xt+1 3 ln Zt+1 ) (ln 2 + ln Xt 3 ln Z
| {z }
growth rate: gY
= ln Xt+1 ln Xt 3(ln Zt+1 ln Zt )
| {z } | {z }
growth rate: gX growth rate: gZ
4 So this power function can be written in ∆log as

gY = gX 3gZ

Transforming functions into log-di¤erences: fourth

case
1 The last function we need to consider is an additive function like
Yt+1 = Xt+1 + Zt+1
2 Here we can’t apply logs. But there is another way

3 Firstly, multiply and divide through as follows
Yt + 1 Xt+1 Zt+1
Yt = Xt + Zt .
Yt Xt Zt
Yt+1
4 Now apply the following: = 1 + gY , XXt+t 1 = 1 + gX ,
Yt
Zt+1
Zt = 1 + gZ , and the previous eq. can be written as
(1 + gY ) Yt = (1 + gX ) Xt + (1 + gZ ) Zt
5 Divide through by Yt and get
Xt Zt
1 + gY = (1 + gX ) + ( 1 + gZ )
Yt Yt
Transforming functions into log-di¤erences: fourth

case (cont.)
1 Notice that the previous equation can be written as
Xt Zt Xt Zt
1 + gY = + + gX + gZ
Yt Yt Yt Yt
| {z }
=(Xt +Zt )/Yt =1
2 Therefore, an additive function like Yt+1 = Xt+1 + Zt+1 can be

expressed as
Xt Zt
gY = gX + gZ
Yt Yt
3 Notice that if Z = 2, its growth rate were z = 0, and we would get

Xt
gY = gX
Yt

Transforming functions into log-di¤erences:

summary
1 Let’s summarize our results
Variables in levels Variables in ∆logs
Yt = 2Xt , gY = gX
Yt = 2Xt Zt , gY = gX + gZ
3
Yt = 2Xt Zt , gY = gX 3gZ
Xt Zt
Yt+1 = Xt+1 + Zt+1 , gY = gX Yt + gZ Yt
Xt
Yt + 1 = Xt + 1 + a , gY = gX Yt

Chapter 3. An Overview of Long-Run Economic Growth

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An Overview of Long-Run Economic

Dep. of Economics — Instituto Universitário de Lisboa

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 1 / 36

1 Growth over the Very Long Run

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 2 / 36

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 3 / 36

The Great Divergence

1 Sustained increases in standards of living are a recent phenomenon.

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 4 / 36

Graph of the Great Divergence

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 5 / 36

II –Modern Economic Growth

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 6 / 36

The amazing improvement in living standards

1 From 1870 to 2000, United States per capita GDP ...

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 7 / 36

Per capita GDP in the United States

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 8 / 36

The De…nition of Economic Growth

1 Growth of per capita GDP

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 9 / 36

The Rule of 70 and the Ratio Scale

1 If y grows at a rate of g percent per year, then the number of years it

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 10 / 36

The absolute vsersus ratio scale

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 11 / 36

GDP has been rising since the 1880’s

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 12 / 36

Calculating Growth Rates

1 The rule for computing

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 13 / 36

III –Modern Growth around the World

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 14 / 36

Real Economic Convergence

1 After World War II, growth in Germany and Japan accelerated.

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 15 / 36

Real convergence in a ratio scale

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 16 / 36

Convergence: A Broad Sample of Countries

1 Over the period 1960–2007

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 17 / 36

The lack of convergence

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 18 / 36

IV –Some Useful Properties of Growth

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 19 / 36

Real Economic Convergence

1 Growth rates of ratios, products, and powers follow several simple

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 20 / 36

Transforming functions into log-di¤erences:

Variables in levels Variables in ∆logs

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 21 / 36

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 22 / 36

Growth Rules in a Famous Example

1 Original output equation

2 In terms of growth rates we have

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 23 / 36

Growth Rules in a Famous Example

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 24 / 36

V –The Costs of Economic Growth

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 25 / 36

The bene…ts of economic growth

(Vivaldo Mendes – ISCTE-IUL ) Macroeconomics I (L0271) 1 October 2019 26 / 36

The Costs of economic growth