Long Run Economic Growth Agenda. Long-run Economic Growth. Long-run Growth Model. Long-run Economic Growth. Determinants of Long-run Growth

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Easter Conley
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1 Long Run Economic Growth Agenda Long-run economic growth. Determinants of long-run growth. Production functions. Long-run Economic Growth Output is measured by real GDP per capita. This measures our (material) standards of living. Small changes in growth rates can make large differences over long periods of time. Advantages of rapid economic growth. Disadvantages of rapid economic growth. 1 2 Long-run Economic Growth Long-run Growth Model Attempts to explain level of, and changes in, real GDP per capita,. Describes an economy where Supply and demand for goods are in equilibrium. Prices fully adjust to equate supply and demand. Supply and demand for labor are in equilibrium. Wages fully adjust to equate supply and demand. 1,500BCE 0 500CE A time period of years or even longer. Long-run Growth Model Model will help to explain: Growth rates over long periods of time. Why long-term growth rates slow or accelerate. Why growth rates differ between countries. ModeN does not explain cyclical fluctuations. That is, does not help explain business cycles. Determinants of Long-run Growth Three important determinants: Labor, N Capital, K Technology (or productivity), A 5 6 1

Disadvantages of rapid economic growth. 1 2 Long-run Economic Growth Long-run Growth Model Attempts to explain level of, and changes in, real GDP per capita,.

2 Labor, N The number of worker in the labor force. We assume that all workers have similar skills. Growth of the labor force Versus the population. Importance of labor force participation rate. Capital, K The sum total of all of the equipment, structures and other productive facilities in the economy. Comes from net I in all previous years. Long-run growth model assumes: Always at the natural rate of unemployment, U*. Therefore, always at potential output, *. 7 8 Technology, A The sum total of our knowledge about how to use N and K to produce. Anything that influences the productivity of both N or K evenly: New equipment technology. Business organization and management. The most abstract of the production inputs and the most difficult to measure. 9 Production functions show how businesses transform factors of production into output of goods and services. Output is produced by N and K through the application of A. = F( N, K, A ) Shows how much can be produced from a given amounts of N, K, and A. Cobb-Douglas: = A N α K 1-α 10, 1, 1 Graphically in, N space: Shows how depends on N for given K and A. Exhibits increasing returns to N. Exhibits diminishing marginal returns to N Slope is the marginal product of labor = F( N, K, A ) 11 N 12 2

Long-run growth model assumes: Always at the natural rate of unemployment, U*. Therefore, always at potential output, *.

3 , 1 What happens if K or A changes?, 1a = F( N, K1, A1 ) = F( N, K, A ) Where K1 > K and/or A1 > A 13 N 14, 2, 2 Graphically in, K space: = F( N, K, A ) Shows how depends on K for given N and A. Exhibits increasing returns to K. Exhibits diminishing marginal returns to K. Slope is the marginal product of capital. 15 K 16, 2 What happens if N or A changes?, 2a = F( N1, K, A1 ) = F( N, K, A ) Where N1 > N and/or A1 > A 17 K 18 3

N, K, A ) Shows how depends on K for given N and A. Exhibits increasing returns to K.

4 , 3 Graphically in, A space:, 3 = F( N, K, A ) Shows how depends on A. A does not depend on N or K. Exhibits increasing returns to A. Exhibits constant marginal returns to A. 19 A 20 = F( N, K, A ) Because we define A so that it affects N and K evenly we can re-write this as: Then this allows us to divide through by any number without changing the relationship: = A * F( N, K ) If we also assume constant returns to scale: If N and K double, doubles for a given A. 2 = A * F( 2N, 2K ) 21 = A * f ( ) is called the capital-to-labor ratio. depends on A and. And is what we want to explain. 22 THE Production Function = A * f( ) What happens if: N changes? K changes? A changes?

19 A 20 = F( N, K, A ) Because we define A so that it affects N and K evenly we can re-write this as: Then this allows us to divide through by any number without changing

5 Changes in N or K Increase in A = A1 * f( ) = A * f( ) = A0 * f( ) If N or K changes, move along the horizontal and vertical axes and the production function. A1 > A

The Short-Run Macro Model. The Short-Run Macro Model. The Short-Run Macro Model

The Short-Run Macro Model. The Short-Run Macro Model. The Short-Run Macro Model The Short-Run Macro Model In the short run, spending depends on income, and income depends on spending. The Short-Run Macro Model Short-Run Macro Model A macroeconomic model that explains how changes in