ECO2004S

MACROECONOMICS II

Chapter
CHAPTER 10 11
Savings, capital accumulation & output
THE FACTS OF GROWTH

Refilwe Lepelle
 Office hours

Tuesdays 14:00 - 16:00

School of Economics, Middle Campus

Office: 5.10.5

Email: refilwe.lepelle@uct.ac.za
 Key questions

• What are the interactions between output and capital

accumulation?

• What are the dynamics of capital and output over time?

• What is the steady-state capital and output?

• How does the saving rate affect the growth rate of output per
worker?

• What is the golden rule level of capital?

 What we will cover
1 - The effects of capital on output.
The interaction between
output and capital - The effects of output on capital
accumulation.

- The dynamics of capital and

2 output.
The implications of
alternative savings rates
- Steady-state capital and output.

- Savings rate and output.

- Savings rate and consumption.

Interactions between output and capital
 Interactions between Output and Capital

Output in the long run is determined by two basic relations between

output and capital:

1. The amount of capital determines the amount of output being

produced.

2. The amount of output determines the amount of saving and, in

turn, the amount of capital accumulated over time.
 Interactions between output and capital

Capital, Output, and Saving/Investment

Capital Stock Output or Income

Change in capital stock Savings or Investment

 Interactions between output and capital
Under constant returns to scale, we can write the relation between
output and capital per worker as follows:

Recall chapter 10: Output per worker (Y/N) is an increasing function

of capital per worker (K/N) but at a decreasing rate – decreasing
returns to capital.
 The Effects of capital on output:
Assumption 1
The size of the population, participation rate, and unemployment rate are all constant.

Labour force = population x participation rate

Employment = labour force x (1 – unemployment rate)

Employment is constant.

N is constant.
The Effects of capital on output:
Assumption 2
There is no technological progress.

The production function remains unchanged.

f does not change over time.

 Interactions between Output and Capital

The Effects of Capital on Output: Production Function

With these two assumptions, our first relation between output and
capital per worker, from the production side, can be written as:

Higher capital per worker leads to higher output per worker.

First equation of the model

 Interactions between Output and Capital

The Effects of Output on Capital Accumulation

To derive the second equation we proceed in two steps:

1. We derive the relation between output and investment.

2. We derive the relation between investment and capital

accumulation.
 Interactions between Output and Capital
The Effects of Output on Capital Accumulation

Output and Investment

Assume the following:

1. The economy is closed: I = S + (T − G)

2. Public saving, (T − G) is equal to 0, therefore: I=S

3. Private saving is proportional to income (0 < s < 1): S = sY

So the relation between output and investment:

=  

 Investment is proportional to output.

 The higher (lower) output is, the higher (lower) is saving and so the higher (lower)
is investment.
 Interactions between Output and Capital

The Effects of Output on Capital Accumulation

To derive the second equation we proceed in two steps:

1. We derive the relation between output and investment.

2. We derive the relation between investment and capital

accumulation.
 Interactions between Output and Capital
•  
The Effects of Output on Capital Accumulation

Investment and Capital Accumulation

• The evolution of the capital stock is given by:

=  
denotes the rate of depreciation

• Combining the relation from output to investment, =   with the

relation from investment to capital accumulation, and dividing both sides
by N, we obtain:

=  
 Interactions between Output and Capital
The Effects of Output on Capital Accumulation

Investment and Capital Accumulation

=  
Output and Capital per Worker:

Rearranging we can articulate the change in capital per worker over time:
- = -  

Second equation of the model

The change in the capital stock per worker (left side) is equal to saving per worker minus
depreciation (right side).
Implications of Alternative Savings Rates
 What we will cover

The implications of alternative savings rates

- The dynamics of capital and output.

- Steady-state capital and output.
- Savings rate and output.
- Savings rate and consumption.
 Dynamics of Capital and Output
The two basic equations are:
Production Function: Capital determines Capital accumulation: Output determines
output. capital accumulation.

and

Combining the two relations, we can study the behaviour of output and capital over
time.
 Dynamics of Capital and Output

The change in capital per worker from this year to next year depends on the
difference of the two terms:

Investment per worker: if investment per worker exceeds depreciation per

worker, the change in capital per worker is positive: capital per worker
increases.

Depreciation per worker: If investment per worker is less than depreciation per
worker, the change in capital per worker is negative: capital per worker
decreases.
Dynamics of Capital and Output
Figure 11-2: Capital and Output Dynamics

Investment per worker increases with

capital per worker, but by less and
less as capital per worker increases.

Depreciation per worker increases in

proportion to capital per worker.

At /N capital per   worker is low,

investment exceeds depreciation, thus,
capital per worker and output per
worker will increase over time.
 Dynamics of Capital and Output
Figure 11-2: Capital and Output Dynamics

When capital and output are low,

investment > depreciation, and capital
increases.

When capital and output are high,

investment < depreciation, and capital
decreases.

At K*/N, output per worker and

capital per worker remain constant at
their long-run equilibrium levels
steady-state.

Convergence towards the SS

 Steady-state of the Economy

Definition: The state in which output per worker and capital per worker
are no longer changing.
Therefore:

The left side of the equation above equals zero, then:

 Steady-state Capital and Output

The steady-state value of capital per worker is such that the amount
of saving per worker is sufficient to cover depreciation of the capital
stock per worker.
 Steady-state Capital and Output

Given the steady-state value of capital per worker (K*/N), the

steady-state value of output per worker (Y*/N), is given by the
production function:
 The Saving Rate and Output
How does the saving rate affect the long run growth rate of output per
worker?

- The saving rate has no effect on the long run growth rate of output per
worker, which is equal to zero.

How does the saving rate affect the long run level of output per
worker?

- Other things equal, countries with a higher saving rate will achieve
higher output per worker in the long run.

- An increase in the saving rate will lead to higher growth of output

per worker for some time, but not forever.
 Implications of Alternative Savings Rates
The Saving Rate and Output

Figure 11-3: The effects of different saving rates

A country with a higher

saving rate achieves a
higher steady-state level of
output per worker.
Implications of Alternative Savings Rates
The Saving Rate and Output

Figure 11-4: The effects of an increase in the saving rate on output per worker in an
economy without technological progress.

An increase in the saving

rate leads to a period of
higher growth until output
reaches its new higher
steady-state level.
 Implications of Alternative Savings Rates
The Saving Rate and Output

Figure 11-5 The effects of an increase in the saving rate on output per worker in an
economy with technological progress

An increase in the saving

rate leads to a period of
higher growth until output
reaches its new higher
steady-state level.
 The Saving Rate and Consumption
Governments can affect the saving rate by:

1. Changing public saving (e.g. budget surplus).

2. Using taxes to affect private saving (e.g. tax breaks).

 The Saving Rate and Consumption
• What matters to people is not how many is produced, but how much they
consume.

• An increase in saving comes initially with an equal decrease in

consumption.

• Consumption may decrease not only initially but also in the long run.

To show this we use 2 extreme cases:

1. If the saving rate is zero, output is also equal to zero and consumption
will also be zero.

2. If saving rate is one people save all their income. The level of capital
and output will be very high. But consumption will be zero.
 The Saving Rate and Consumption

Golden-rule level of capital

The level of capital associated with the saving rate that yields the
highest level of consumption in steady-state.
 The Saving Rate and Consumption
Figure 11-6: The effects of the saving rate on steady-state consumption per worker.

For a saving rate between

  zero and the
golden-rule level (), a higher saving rate
leads to higher capital per worker,
higher output per worker and higher
consumption per worker.
 The Saving Rate and Consumption
Figure 11-6: The effects of the saving rate on steady-state consumption per worker.

For a saving rate greater than the

golden-rule level, a higher saving rate
still leads to higher capital per worker
and output per worker, but lower
consumption per worker.
 Exercises: Finding the Steady-State

 
•Assume the following Cobb-Douglas production function:

= share of capital <1

1. Express the production function in per capita terms.

2. Find the steady state values for:

• Capital per capita
• Output per capita

Note: L or N for labour force!

 Exercises: Finding the Steady-State
𝛼 1− 𝛼 𝛼
1.𝑌 = 𝐾 𝑁  𝛼 − 𝛼 𝐾
𝑁 𝑁
=𝐾 𝑁 =
𝑁 ( ) =𝑘
𝛼

2.  
and

In SS: Capital per worker

𝛼
𝐾 𝑡 +1 𝐾𝑡   𝐾𝑡 𝐾𝑡
𝑁
−
𝑁
=0 𝑠
𝑁 ( ) =𝛿( )
𝑁

 
 Exercises: Finding the Steady-State

In SS output per worker:

•

Need to substitute in the production

function expressed in per capita terms

THANK YOU