Economic growth in the long run

GOLDEN RULE

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Question one

During the 1950s and 1960s, Germany and Japan had much faster rates of
economic growth than did the United States. What might account for these
differences in growth rates? Did these differences occur because of a
fundamental defect in the U. S. economy?

Answer:

One explanation for the higher growth rates of Japan and Germany is that
those countries ended World War II with much lower capital stocks per worker
than the United States had. If all three countries have the same technology and
the same preferences for consumption versus leisure and for current versus
future consumption (i.e., the same saving behavior), they should all eventually
converge to the same capital-labor ratio. During the years when Japan and
Germany were building up their capital stocks, they would grow at a faster rate
than the United States. This pattern of growth rates would not imply any
fundamental defect in the U.S. economy.

Question

Three possible sources of growth in per capita output are:

i. population growth

ii. Capital accumulation

iii. Technological progress

a. Which of these factors can account for growth in per capita output
during a country's transition to a long-run, steady-state equilibrium? Explain.
Give some real-world examples.

b. Which factors can account for continuing growth in per capita output
once the long-run steady state has been reached? Explain.

Answer:

Both technical progress and capital accumulation can contribute to the growth
of per capita output during a country's transition to a long-run, steady-state
equilibrium, with capital accumulation being likely to play a particularly
important role. (This assumes the country is starting out below the steady-
state capital stock.) Numerous examples could be cited, but the rapid growth of
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Germany and Japan after World War II are particularly striking. Once the
steady state has been reached, only technical progress can sustain continued
growth of per capita output. Capital accumulation alone will be ineffective
because the marginal product of capital declines as more capital is added and
eventually falls below the increased depreciation resulting from a higher capital
stock. A higher rate of population growth would slow a country's approach to a
steady-state equilibrium and would cause the level of per capita output to be
lower once the steady state is reached.

Question

Why don’t all countries converge to the same level of per capita GDP as the
United States, Germany, and Japan?

Some countries seem to have different levels of technology (interpreted broadly

to include factors like political stability, the legal system, the security of
property rights, the ability to enforce contracts, etc.)

Question

What explains the long-run growth of aggregate GDP?

Growth of labor, capital, and technology

Question

How does an increase in the population growth rate affect economic growth?

In the Solow model, an increase in the population growth rate raises the
growth rate of aggregate output but has no permanent effect on the growth rate
of per capita output. An increase in the population growth rate lowers the
steady-state level of per capita output.

Question

In Solow growth model, explain what condition must occur for each of the
following to occur:

(1) The capital stock to increase;

(2) The capital stock to decrease; and.

(3) The capital stock to remain constant

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In the Solow growth model, the capital stock is determined by the balance
between investment and depreciation. The capital stock will increase if the
investment of the economy is more than the depreciation on the capital stock,
it will decrease if the depreciation is more than investment, and it will remain
constant if the investment and depreciation are equal.

Mathematically, let K be the capital stock, I be investment, and 8 be

depreciation. Then, we have:

1. The capital stock will increase if I > δ. In this case, the investment is greater
than depreciation, resulting in a net increase in the capital stock.

2. The capital stock will decrease if I < δ. In this case, the depreciation is
greater than investment, resulting in a net decrease in the capital stock.

3. The capital stock will remain constant if I = δ. In this case, the investment
and depreciation are equal, resulting in no net change in the capital stock.

Note that investment is assumed to be a constant fraction of output, denoted

by "s", so I = SY, where Y is the level of output of the economy. Similarly,
depreciation is assumed to be a constant fraction of the capital stock, denoted
by “δ ", so SK. = SY.

Hence, we can also state the above conditions as:

1. The capital stock will increase if SY > SK.

2. The capital stock will decrease if SY < SK.

3. The capital stock will remain constant if SY = SK

Question

Graphically illustrate and explain the effects of an increase in population

growth on the Solow growth model. In your answer, you must clearly label all
curves and the initial and final equilibria. In your answer, explain what
happens to the rate of growth of output per worker and the rate of growth of
output as the economy adjusts to this increase in population growth

Answers

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In the Solow growth model, an increase in population growth rate will affect the
equilibrium level of output and capital stock per worker. Specifically, the
increase in population growth rate will shift the break-even investment rate
(i.e., the investment rate which balances the depreciation rate) to the right.

Here's how this change would look graphically:

As the economy adjusts to the new equilibrium, the rate of growth of output
per worker will decrease since the output per worker is decreasing at the new
equilibrium. Meanwhile, the rate of growth of output will remain the same, as
the rate of technological progress is assumed to be constant in the Solow
growth model.

In summary, an increase in population growth rate leads to a decline in output

per worker and an increase in an increase in population growth rate leads to a
decline in output per worker and an increase in capital stock per worker in the
short run. However, in the long run, the increase in population growth rate
leads to a lower level of output per worker and a higher level of capital per
worker than the initial equilibrium. The rate of growth of output per worker
decreases, while the rate of growth of output remains the same. Overall, the
Solow growth model highlights the trade-off between population growth and
economic growth, and how changes in one factor can affect the equilibrium
levels of others.

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