11Long Run Economic GrowthAgenda• Long-run economic growth.• Determinants of long-run growth.• Production functions.2Long-run Economic Growth• Output is measured by real GDP per capita.¾ Y/N¾ This measures our (material) standards of living.• Small changes in growth rates can make large differences over long periods of time.¾ Advantages of rapid economic growth.¾ Disadvantages of rapid economic growth.3Long-run Economic GrowthY/N1,500BCE 0 500CE 1000 1500 1750 2000 4Long-run Growth Model• Attempts to explain level of, and changes in, real GDP per capita, Y/N.• Describes an economy where¾ Supply and demand for goods are in equilibrium.• Prices fully adjust to equate supply and demand.¾ Supply and demand for labor are in equilibrium.• Wages fully adjust to equate supply and demand.• A time period of 10 - 25 years or even longer.5Long-run Growth Model• Model will help to explain:¾ Growth rates over long periods of time.¾ Why long-term growth rates slow or accelerate.¾ Why growth rates differ between countries.• ModeN does not explain cyclical fluctuations.¾ That is, does not help explain business cycles.6Determinants of Long-run Growth• Three important determinants:¾ Labor, N¾ Capital, K¾ Technology (or productivity), A27Labor, N• The number of worker in the labor force.¾ We assume that all workers have similar skills.• Growth of the labor force¾ Versus the population.¾ Importance of labor force participation rate.• Long-run growth model assumes:¾ Always at the natural rate of unemployment, U*.¾ Therefore, always at potential output, Y*.8Capital, K• The sum total of all of the equipment, structures and other productive facilities in the economy.¾ Comes from net I in all previous years.9Technology, A• The sum total of our knowledge about how to use N and K to produce Y.• Anything that influences the productivity of both N or K evenly:¾ New equipment technology.¾ Business organization and management.• The most abstract of the production inputs and the most difficult to measure.10The Production Function• Production functions show how businesses transform factors of production into output of goods and services.¾ Output is produced by N and K through the application of A.• Y = F( N, K, A )¾ Shows how much Y can be produced from a given amounts of N, K, and A.• Cobb-Douglas: Y = A NαK1-α11The Production Function, 1• Graphically in Y, N space:¾ Shows how Y depends on N for given K and A.¾ Exhibits increasing returns to N.¾ Exhibits diminishing marginal returns to N• Slope is the marginal product of labor12The Production Function, 1NYY = F( N, K, A )313The Production Function, 1• What happens if K or A changes?14The Production Function, 1aNYY = F( N, K, A )Y = F( N, K1, A1 )Where K1 > K and/orA1 > A15The Production Function, 2• Graphically in Y, K space:¾ Shows how Y depends on K for given N and A.¾ Exhibits increasing returns to K.¾ Exhibits diminishing marginal returns to K.• Slope is the marginal product of capital.16The Production Function, 2KYY = F( N, K, A )17The Production Function, 2• What happens if N or A changes?18The Production Function, 2aKYY = F( N, K, A )Y = F( N1, K, A1 )Where N1 > N and/orA1 > A419The Production Function, 3• Graphically in Y, A space:¾ Shows how Y depends on A.• A does not depend on N or K.¾ Exhibits increasing returns to A.¾ Exhibits constant marginal returns to A.20The Production Function, 3AYY = F( N, K, A )21The Production Function• Y = F( N, K, A )¾ Because we define A so that it affects N and K evenly we can re-write this as:• Y = A * F( N, K )¾If we also assume constant returns to scale:• If N and K double, Y doubles for a given A.• 2Y = A * F( 2N, 2K )22The Production Function• Then this allows us to divide through by any number without changing the relationship:¾ Y/N = A * f ( K/N )• K/N is called the capital-to-labor ratio.¾ Y/N depends on A and K/N.• And Y/N is what we want to explain.23THE Production FunctionK/NY/NY/N = A * f( K/N )24The Production Function• What happens if:¾ N changes ?¾ K changes ? ¾ A changes ?525Changes in N or KK/NY/NY/N = A * f( K/N )If N or K changes, move along the horizontal and vertical axes and the production function.26Increase in AK/NY/NY/N = A0 * f( K/N )Y/N = A1 * f( K/N )A1 >
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