1macroeconomicsfifth editionN. Gregory MankiwPowerPoint®Slides by Ron CronovichCHAPTER SEVENEconomic Growth I macro © 2002 Worth Publishers, all rights reserved(ch. 7)Topic 4:Economic Growth I(chapter 7)CHAPTER 7CHAPTER 7 Economic Growth IEconomic Growth Islide 1Chapter 7 learning objectivesChapter 7 learning objectives§ Learn the closed economy Solow model § See how a country’s standard of living depends on its saving and population growth rates§ Learn how to use the “Golden Rule ”to find the optimal savings rate and capital stockCHAPTER 7CHAPTER 7 Economic Growth IEconomic Growth Islide 2selected poverty statisticsselected poverty statisticsIn the poorest one-fifth of all countries,§ daily caloric intake is 1/3 lower than in the richest fifth§ the infant mortality rate is 200 per 1000 births, compared to 4 per 1000 births in the richest fifth.§ …2CHAPTER 7CHAPTER 7 Economic Growth IEconomic Growth Islide 3Income and poverty in the world Income and poverty in the world selected countries, 2000selected countries, 20000102030405060708090100$0 $5,000 $10,000 $15,000 $20,000Income per capita in dollars% of population living on $2 per day or lessMadagascarIndiaBangladeshNepalBotswanaMexicoChileS. KoreaBrazilRussian FederationThailandPeruChinaKenyaCHAPTER 7CHAPTER 7 Economic Growth IEconomic Growth Islide 4Huge effects from tiny differencesHuge effects from tiny differencesIn rich countries like the U.S., if government policies or “shocks ”have even a small impact on the long-run growth rate, they will have a huge impact on our standard of living in the long run…CHAPTER 7CHAPTER 7 Economic Growth IEconomic Growth Islide 5Huge effects from tiny differencesHuge effects from tiny differences1,081.4%243.7%85.4%624.5%169.2%64.0%2.5%2.0%…100 years…50 years…25 yearspercentage increase in standard of living after…annual growth rate of income per capita3CHAPTER 7CHAPTER 7 Economic Growth IEconomic Growth Islide 6Huge effects from tiny differencesHuge effects from tiny differencesIf the annual growth rate of U.S. real GDP per capita had been just one-tenth of one percent higher during the 1990s, the U.S. would have generated an additional $449 billion of income during that decadeCHAPTER 7CHAPTER 7 Economic Growth IEconomic Growth Islide 7The lessons of growth theoryThe lessons of growth theory……can make a positive difference in the can make a positive difference in the lives of hundreds of millions of people.lives of hundreds of millions of people.These lessons help us§ understand why poor countries are poor§ design policies that can help them grow§ learn how our own growth rate is affected by shocks and our government’s policiesCHAPTER 7CHAPTER 7 Economic Growth IEconomic Growth Islide 8The Solow ModelThe Solow Model§ due to Robert Solow,won Nobel Prize for contributions to the study of economic growth§ a major paradigm:– widely used in policy making– benchmark against which most recent growth theories are compared§ looks at the determinants of economic growth and the standard of living in the long run4CHAPTER 7CHAPTER 7 Economic Growth IEconomic Growth Islide 9How Solow model is different from How Solow model is different from Chapter 3Chapter 3’’s models model1. _______________________investment causes it to grow, depreciation causes it to shrink.2. _________________________population growth causes it to grow. 3. The consumption function is simpler.CHAPTER 7CHAPTER 7 Economic Growth IEconomic Growth Islide 10How Solow model is different from How Solow model is different from Chapter 3Chapter 3’’s models model4. No G or T(only to simplify presentation; we can still do fiscal policy experiments)5. Cosmetic differences.CHAPTER 7CHAPTER 7 Economic Growth IEconomic Growth Islide 11The production functionThe production function§ In aggregate terms: Y = F (K, L )§ Define: y = _______________k = _______________§ Assume ____________________:zY = F (zK, zL ) for any z > 0§ Pick z = 1 /L. Then Y/L = F (K/L , 1)y = F (k, 1)y = f(k) where f(k) = F (k, 1)5CHAPTER 7CHAPTER 7 Economic Growth IEconomic Growth Islide 12The production functionThe production functionOutput per worker, yCapital per worker, kf(k)Note: this production function exhibits ________ MPK. 1MPK =_________CHAPTER 7CHAPTER 7 Economic Growth IEconomic Growth Islide 13The national income identityThe national income identity§ Y = C + I (remember, no G )§ In “per worker” terms: _________where c = ____ and i = ____CHAPTER 7CHAPTER 7 Economic Growth IEconomic Growth Islide 14The consumption functionThe consumption function§ s = the saving rate, ________________________(s is an exogenous parameter)Note: Note: ss is the only lowercase variable is the only lowercase variable that is not equal to that is not equal to its uppercase version divided by its uppercase version divided by LL§ Consumption function: __________(per worker)6CHAPTER 7CHAPTER 7 Economic Growth IEconomic Growth Islide 15Saving and investmentSaving and investment§ saving (per worker) = y – c= ________= _____§ National income identity is y = c + iRearrange to get: __________(investment = saving, like in chap. 3!) § Using the results above, _____________CHAPTER 7CHAPTER 7 Economic Growth IEconomic Growth Islide 16Output, consumption, and investmentOutput, consumption, and investmentOutput per worker, yCapital per worker, k______k1______CHAPTER 7CHAPTER 7 Economic Growth IEconomic Growth Islide 17DepreciationDepreciationDepreciation per worker, δkCapital per worker, kδkδ = the rate of depreciation =_________________________1_7CHAPTER 7CHAPTER 7 Economic Growth IEconomic Growth Islide 18Capital accumulationCapital accumulationThe basic idea:The basic idea:Investment makes Investment makes the capital stock bigger,the capital stock bigger,depreciation makes it smaller.depreciation makes it smaller.CHAPTER 7CHAPTER 7 Economic Growth IEconomic Growth Islide 19Capital accumulationCapital accumulationChange in capital stock = investment – depreciation∆k = __ – __kSince i = sf(k) , this becomes:∆k = __________CHAPTER 7CHAPTER 7 Economic Growth IEconomic Growth Islide 20The equation of motion for The equation of motion for kk§ the Solow model’s central equation§ Determines behavior of capital over time…§ …which, in turn, determines behavior of all of the other endogenous variables because they all depend on k. E.g., income per person: