What does the Generic Growth Structure look like?

SEE IN NOTES

What are the main assumptions behind the Harrod-Domar Model?

- Economy is closed to trade and Foreign investment (Investment = Domestic Savings (S = I))
- Capital (K) and Labour (L) are used in fixed proportion can’t sub in one for the other (Check ISOQUANT graph)
- Capital is limiting factor to growth not labour (L is in unlimited supply)

What are the main assumptions behind the Harrod-Domar Model?

- Constant Returns to Scale (Return to capital at margin always same no matter lvl of stock of capital)
- Production Function such that fixed Q of additional capital (ΔK) gives proportional increase in output (ΔY)

THIS IS THE ICOR (ΔK/ΔY)

What is the ICOR?

incremental capital output ratio

-> The higher the ICOR, the less productive the technology is, i.e., economy will need more capital for a

unit of increment of output (ΔY = 1).

->the inverse of the marginal productivity of capital (ΔY/ΔK).

What is the Structural Form of the model (i.e the 3 Equations in Harrod-Domar)

- Aggregate Production Function = ΔY = (1/k) ΔK
- Savings function = St = sYt

Where St =Agg savings, s = rate of savings out of national income Yt - Investment Function = Demand for invest (It) = to available savings (St)

(I = AK = S) (Invst = Stock of Capital)

A is tech changes

Following the 3 equations therefore what is the growth rate denoted as in the Harrod Domar Model?

Y dot = ΔY/Y = I/K X AK/Y = 1/K x s/Y = S/K

Y dot increases with rate of savings (s) and with decrease in ICOR (k)

What is the growth rate denoted as if we account for depreciation of K? (Harrod Domar)

ΔK = I - δk means

Y dot = s/k - δ

What does the growth rate with depreciation of k explain? (Harrod Domar)

Explains 0 and negative growth (if depreciation greater than savings)

- If we want econ growth we increase lvl of savings, limit depreciation,

What is the growth rate denoted by if we factor in per capita income in the Harrod Domar Model

Per capita income = (y=Y/P)

y dot = Y dot - P dot =s/k -(δ+n)

Growth increase with s, increases with ICOR down, decrease with δ, decrease with n

What is the first application used for the Harrod Domar Model (Foreign Aid) show?

If Foreign Aid = f yt then:

st = sYt + fYt making growth = s+f/k

SEE V.GOOD EXAMPLE IN NOTES

What is the second application used for the Harrod Domar Model (Two Gap Model) show?

- > Assumes econ made up of 2 types of input = domestic inputs (via domestic finance) and foreign-origin inputs (via foreign finance)
- > Assumes production function imply fixed proportions -. One input binds the other

Foreign aid only effective if there has been deficit of foreign finance needed to complement domestic savings for production

Popular with Latin America Countries in 60’s

What is the third application used for the Harrod Domar Model (Two Sector Soviet Model) show?

- > Econ made up of capital goods and consumption goods sector
- > Shows Harrod Domar leads to capital fundamentalism: Over emphasis on savings for capital investment = lower consumption and austerity

SEEN IN CENTRAL PLANNED ECONOMIES USSR

What are the Strengths of the Harrod Domar model?

-Simplicity – data (variables) required is easily

accessible for most countries.

Representative (some empirical support) in

absence of major shocks

Focuses on key role of Savings.

What are the weaknesses of the Harrod Domar Model?

- Over emphasises on Savings – implies Savings is

sufficient (but is it really?). - Other factors e.g. Poor investment decisions,

Government policies, Volatile prices, etc. can impact the outcomes. - Does not consider a multi-sector society i.e. ignores allocation issues.
- Assumes fixed Capital-Labour ratio; Capital-Output;

and Labour-Output ratios L-shaped Isoquants (very unlikely in real economies)

5.Assumes Closed economy - Increases in the ICOR does not necessarily imply

inefficiency or slower growth. Other factors matter.

How does the Solow Model improve upon the Harrod Domar model?

- Recognises the decreasing marginal product of the factors of production (as individual inputs NOT JOINT)
- Allows for possible substitutability between Labour (L) and Capital (K) in production.
- Solow’s model also recognises major role played by TFP growth (leading to curved isoquants see graph in notes)

What does the Solow Production Function look like and denoted like?

Y = A f(K,L) (Function of capital and labour)

A = TFP

SEE GRAPH IN NOTES

How is the Solow Production Function written as in per capita terms?

Y/L = A f (K/L) or y = Af (k)

Where:

->y = Y/L is the productivity of labour (or income per

capita since L is also population)

->k = K/L is capital intensity (the Capital-Labour ratio), or

the stock of capital per worker.

What is Factor Deepening?

Capital grows faster than labour meaning K/L increases (X axis)

SEE DEEPENING GRAPH ON NOTES

What is Factor Widening?

Capital Stock grows at same rate as labour so K constant as proportion of inputs the same

SEE WIDENING GRAPH IN NOTES

What is the Solow Residual?

When we increase K in proportion to L, some of the growth is attributed to factor deepening but a large chunk is due to some unexplained technical change

SEE DEEPENING GRAPH

What is meant by the issue that the Solow model can’t explain the TFP?

The model gives major role to TFP as source of growth but not explain it

-> All it does is tell us about how increased TFP = increased growth but not about the sources of TFP (i.e the residual)

What is the Steady State Condition?

Where an economy is technically grown and stable

syt = ( n + δ) k -> AK = 0

Explains economies lower in K have more room to grow than those closer to steady state and so grow faster

-> At steady state, Y0, income growth function of n only, since Y0 is constant

SEE GRAPH IN NOTES

What do we see with an increase in Savings in the Solow Model?

More savings, higher steady state

SEE GRAPH IN NOTES

What do we see with an increase in labour growth rate in the Solow Model?

Higher labour = more people have to share existing capital thus the depreciation line (n + δ) k shift left

SEE GRAPH IN NOTES

What does the Solow Model with tech change look like?

SEE GRAPH IN NOTES

What is Solow Model’s convergence argument?

The further away the country, the faster it

approaches the steady state. Poorer countries (with smaller k) should grow faster

What is meant by the Solow Model’s convergence argument?

– Shouldn’t developing countries grow faster then?

Reality shows conditional convergence -> Countries that are similar reach similar steady states (SEE LEC SLIDES FOR STATS)

What are the strengths of the Solow Model?

- Does not assume fixed coefficients production, so

is more realistic - Allows more flexibility (substitutability) compared

to HD model - Emphasizes key role of Savings
- Provides insights into usefulness of technological

change and productivity growth.

What are the weaknesses of the Solow Model?

- Productivity growth is considered as exogenous.

In reality this is unlikely to be true. - Considers only a one-sector situation
- Does not provide the precise pathways that the

factors can influence growth i.e. tells us ‘what’

but not ‘how’. - Suggests unconditional convergence between

poor and high income countries.

What are the problems with the exogenous growth models?

- > Both classical and neoclassical models (Harrod-Domar and Solow) highlight technology as important, but don’t explain where it comes from (or how)
- > Weak/inconsistent empirical evidence

What does Endogenous Growth Theory aim to acheive?

- Endogenize Technology: Explains the role of technology (since factor deepening has decreasing marginal returns)
- Explain conditional economic convergence or even divergence due to uneven technological progress.
- Explain why adoption of (and use of) technology differ across countries – Technology is NOT a universal unimpeded

international public good - Explain role of state/institutions in promoting technological innovations (Research and Development or Technology

adoption).

What does Romer’s endogenous model explain?

A is ‘endogenous’ – firms invest in developing A (the TFP) i.e., R&D for monopoly profits; Research

is cumulative-> Economies of Scale in technology

Total Labour Force = Labour in Production and Labour in Research roles

What are the notable differences between the Classical Model and Endogenous Theory?

SEE LECTURE SLIDES SUPER USEFUL STUFF