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3
Classic, Neoclassical and New Theories
of Economic Growth and Development
Instructor : Tadele Melaku,PhD
.
The classical (Harro-Domar) growth model
2
The classical(Harro-Domar) growth model
3
The classical(Harro-Domar) growth model
Y α 1-α α
AK P A K
P
P
P y Ak α f(k).........................................................................................(9)
where y and k represent per capita income and capital per worker respectively and f ' (k) 0
and f '' (k) 0. The equation y Akα f(k) states that output per worker is a function that
depends on the amount of capital per worker. The more capital with which each worker has
to work, the more output that worker can produce.
10
Solow growth model
11
Solow growth model
Equation (10) states that the total capital stock grows when
savings are greater than depreciation.
As the labor force (P) grows at the rate n per year, the change
in capital per worker (k) is given by:
=> Δkt = syt – (δ + n)kt
=> Δkt = sAkα – (δ + n)k ………………………………...(11)
t t
Equation (11) states that capital per worker grows when
savings are greater than what is needed to equip new
workers with the same amount of capital as existing workers
have.
12
Solow growth model
n
where k* means the level of capital per worker when the
economy is in its steady state. Here we note that k* is a
constant function. If per capita capital stock converges to k*,
then the per capita income will be y* where
13
Solow growth model
Note that at the steady state, capital-labor ratio (k) and thus
per capita income (y) are constant in the long run.
The above equilibrium (steady state) can be seen from the
following figure
f(k)=Akα
(n + δ)k
y* sf(k)= sAkα
k* k
14
Solow growth model
15
Solow growth model
Now, let’s see how the change in s, n, and δ affect the steady
state using simple derivatives.
And then we will deal with the same issue using graphs.
If we increase the rate of savings s a temporary increase in
the rate of per capita output growth is realized.
But, change in s doesn’t affect the long run growth rate
of k* and y* because after the economy has time to adjust, the
capital-labor ratio increases, and so does the output-labor
ratio, but not their rate of growth.
16
Solow growth model
17
Solow growth model
18
Solow growth model
19
International Evidence on Investment Rates and
Income per Person
20
Solow growth model
dk 1 1
*
d
1
As( n)
2 1
0
1 1
dk
dn
*
1
As( n)
2 1
0
21
International Evidence on Population Growth
and Income per Person
22
Solow growth model
f ( k ) = Ak α
(n + δ)k
s'f(k )= s' Ak α
y**
y* sf ( k) = s A k α
k* k** 23
Solow growth model
(n' + δ)k
(n + δ)k
y* sf(k)= sAk α
y**
k* k** 24
Solow growth model
25
Solow growth model
Recall * K A s 1
k
P n
1
As
1
K P
n
1 As
l o g
l o g P
1 n
ld o lgo( gK( K
) ) d l o g ( P )
dK d P
K P n
As
Y 1
Recall y *
P A
n
As
1
Y A P
n
As
log(Y ) log( A)
l o g
log P
1 n
d log(Y ) d log(P)
dY d P
Y P n
26
Solow growth model
27
Solow growth model
28
Conclusion on HDM and Solow Model
29
Problems with the neoclassical theory of
development
31
Technical progress in the Solow model
E
g
E
slide 32
Technical progress in the Solow model
Y F (K , L E )
where L E = the number of
effective workers.
– Hence, increases in labor efficiency have the
same effect on output as increases in the
labor force.
slide 33
Technical progress in the Solow model
Notation:
y = Y/LE = output per effective worker
k = K/LE = capital per effective worker
Production function per effective worker:
y = f(k)
Saving and investment per effective worker:
sy = s f(k)
slide 34
Tech. progress in the Solow model
( + n + g)k = break-even
investment: the amount of
investment necessary to keep k
constant. Where:
k to replace depreciating capital
n k to provide capital for new
workers
g k to provide capital for the new
“effective” workers created by technological
progress
slide 35
Technical progress in the Solow model
k = s ( +n
Actual
Investment,
f(k) +g)k
( + n
break-
even +g ) k
sf(k)
investment
k*
slide 36 Capital per worker, k
The Golden Rule
slide 38
Endogenous Growth Theory
Solow model:
sustained growth in living standards is due to
technical progress
the rate of tech progress is exogenous
Endogenous growth theory:
a set of models in which the growth rate of
productivity and living standards is
endogenous
slide 39
A basic model
slide 40
A basic model
K =sY K
Divide through by K and use Y = AK to
get:
Y K sA
If s A >Y, K income will grow
then
forever, and investment is the “engine of
growth.”
Here, the permanent growth rate depends
on s. In Solow model, it does not.
slide 41
Does capital have diminishing returns or not?
slide 42
A two-sector model
Two sectors:
manufacturing firms produce goods
research universities produce knowledge that
increases labor efficiency in manufacturing
u = fraction of labor in research
(u is exogenous)
Manufactured goods
production function:
Y = F [K, (1-u )EL]
Knowledge production
function:
slide 43
E * = g (u)E
A two-sector model
slide 46
Encouraging technological progress
Patent laws:
encourage innovation by granting temporary
monopolies to inventors of new products
Tax incentives for R&D (knowledge
production)
Grants to fund basic research at universities
Industrial policy:
encourage specific industries that are key for
rapid technical progress
slide 47
Summary main points
slide 48