Saving, Capital
Accumulation,
and Output
Chapter 11
• Outline and re-organization of slides Chapter
11 and Chapter 12.
• For detailed explanations and exercises see
Chapter 11/12 of the textbook and
Chapter11/12 slides.
Solow models
• No technological progress
– No population growth
– With population growth
• Technological progress
– No population growth
– With population growth
Summary
• All variables are measured in real terms,
– transformed to per capita equivalents.
• Solow models
• Dynamics of capital accumulation.
• Steady state (of capital accumulation).
• (Steady state) Effects of saving rate (etc.) on
output per capita and growth.
• Transitional dynamics (from one ST to the other)
• Golden-rule.
Some preliminaries
Convention
• Use CAPITAL letters to represent aggregate
variables
• and LOWER cases to represent their per
worker (capita) equivalents.
• [per worker/per capita, per effective
worker/per effective capita are used
interchangeably]
Aggregate production function
• Aggregate output, (input) factors and
technological progress.
Yt = F ( K t , At Lt )
– Aggregate output: Y_t
– (Input) Factors: K_t and L_t, capital and labor
– Labor-augmented technological progress: (increase in)
A_t. Constant A_t implies no technological progress
– Production function: F, represents how factors are
organized to generate output (maps K and AL to Y)
Restrictions on the aggregate
production function
• Homogenous of degree one in factors
• (Strictly) Increasing in factors
• 2nd order partials are negative
• F(0, .)=0, F(., 0)=0
• Marginal products:
• F1(0, .) -> + infinity, F2(., 0) -> + infinity
• F1(+ infinity, .)=0, F2(., + infinity)=0
Behavioral Assumption in Private
Saving
• Private saving is proportional to aggregate
output:
St = sYt
• s: the constant saving rate, given exogenously.
Saving and investment
• Assume government budget is balanced:
– T-G=0.
• No public saving.
• Investment = National saving = Private saving
I t = sYt
Dynamics of capital accumulation
• Change of capital stock between t and t+1:
K t + I t - Depreciation = K t+1
Depreciation = d K t
d : rateof depreciation per period
• Investment increases capital stock while
depreciation reduces it.
Dynamics of capital accumulation
• Aggregate capital accumulation between t and
t+1:
K t+1 - K t = sYt - d K t
K t+1 - K t = sF ( K t , At Lt ) - d K t
(1)
Demographics (population dynamics)
• Constant population:
Nt+1 = Nt = N for any t
• Growing population
Nt+1 = (1+ gN ) Nt for any t
• gN represents population growth rate.
Labor markets
• Full employment equilibrium
• With no population growth
Lt = N
• With population growth
Lt = Nt
• (Note: even without full employment, as long as
employment is proportional to population, the
qualitative nature of latter results wouldn’t
change.)
Solow model with no population
growth (no technological progress)
Capital accumulation
• From aggregate to per capita measure
K t+1 - K t = sF ( K t , N) - d K t
• Dividing both sides by N, and let kt = K t / N
and f ( kt ) = F ( K t / N,1)
• Note sF ( K t , N) / N = sF ( K t / N,1) = sf ( kt )
• Then per capita accumulation equation
• k - k = sf ( k ) - dk (2)
t+1 t t t
Steady state
• Def.: for some k such that the LHS of (2) is zero,
i.e., per worker capital stock does not change
over time kt+1 = kt
• There are two solutions when the RHS of (2) is
zero. One at k=0, which is unstable; the other
is at k > 0, which is stable. k is referred to
* *
as the steady state.
Figure 11-3 The Effects of Different Saving Rates
Stability of the steady state
• When k is small, the marginal product f’(k) is
large, so sf(k) > delta k, i.e., saving per worker
is larger than depreciation per worker. In this
case, k increases over time.
• When k is large, diminishing marginal product
implies that sf(k) < delta k, i.e., saving per
worker is smaller than depreciation per worker.
In this case, k decreases over time.
Steady state capital per worker
• In the steady state:
• sf ( k ) = dk
* *
(3)
Steady state implications
• At the steady state, k* is constant, so output
per capita f ( k* ) and consumption per
worker (1- s) f ( k* ) are constant.
• There is no economic growth.
• At the steady state, saving is simply used to
replace the depreciated capital stock so as to
keep capital stock per worker at a constant
level.
• Note: the point at the origin is unstable.
Aggregate variables in the steady state
• Aggregate output:
Y / N = f (k )
* *
Y = f (k ) N
* *
• Aggregate consumption:
C = (1- s)Y = (1- s) f ( k ) N
* * *
• Both above measures are constant.
Comparative statics of the steady state
• Increasing saving rate increases the steady
state per capita capital stock k*
• Increasing depreciation rate decreases the
steady state per capita capital stock k*
• The above impacts on the output per capita
can then be deduced.
Transitional dynamics to the new
steady state
• Increasing saving rate
Figure 11-3 The Effects of Different Saving Rates
The figure shows the movement of output per
worker
Figure 11-4 The Effects of an Increase in the Saving Rate on Output
per Worker in an Economy Without Technological Progress
Golden-rule level of capital per
worker(I)
• Def.: The maximum consumption per capita at
the steady state.
• Let c = C / N then the per capita
consumption at the steady state is
• c = f ( k ) - sf ( k ) = f ( k ) - dk
* * * * *
(4)
Golden-rule level of capital per
worker(II)
• Golden-rule is determined by
max k* [ f ( k ) - dk ]
* *
• Golden rule occurs at (FOC)
f '( kG ) = d
*
(5)
Golden-rule level of capital per
worker(III)
• The saving rate implementing the Golden-rule
• Note first that the steady-state capital per
worker is determined by (3), in which s is
treated as exogenous.
• sf ( k ) = dk -> k ( s)
* * *
(4)
• Substituting the above into the FOC for the
Golden-rule, (5), one can find the saving rate
• f '[ k ( sG )] = d
*
(6)
[Solving for the saving rate at
the Golden-rule]
• Alternatively, one can solve first for the steady
state capital per worker from (5).
• Then, using (4) to determine the
corresponding saving rate.
f (k )
*
dk *
sG f ( k ) *
k *
Solow model with population growth
(no technological progress)
Capital accumulation (I)
• Aggregate capital accumulation
K t+1 - K t = sF ( K t , Nt ) - d K t
• Population growth
Nt+1 = (1+ gN ) Nt
Capital accumulation (II)
• Dividing both sides by N_t
K t+1 / Nt - K t / Nt = sF ( K t , Nt ) / Nt - d K t / Nt
• Using population dynamics
(1+ gN ) K t+1 / Nt+1 - K t / Nt = sF ( K t , Nt ) / Nt - d K t / Nt
• Re-arranging
(1+ gN )( K t+1 / Nt+1 - K t / Nt ) = sF ( K t , Nt ) / Nt - (d + gN ) K t / Nt
Capital accumulation (III)
• Per capita capital accumulation
• (1+ gN )( kt+1 - kt ) = sf ( kt ) - (d + gN ) kt (7)
Steady state
• Def.: for some k such that the LHS of (7) is zero,
i.e., per capita capital stock does not change
over time kt+1 = kt
• There are two solutions when the RHS of (7) is
zero. One at k=0, which is unstable; the other
is at k > 0, which is stable. k is referred to
* *
as the steady state.
Stability of the steady state
• When k is small, the marginal product f’(k) is
large, so sf(k) > (delta+g_N) k. In this case, k
increases over time.
• When k is large, diminishing marginal product
implies that sf(k) < (delta+g_N) k. In this case,
k decreases over time.
Steady state capital per worker
• In the steady state:
• sf ( k ) = (d + gN )k
* *
(8)
Steady state implications
• In the steady state, k*is constant, so output
per capita f ( k ) and consumption per
*
worker (1- s) f ( k ) are constant.
*
• There is no economic growth.
• In the steady state, to keep the capital per
worker constant, saving has to cover both the
depreciation and the dilution of capital stock
due to population growth.
Aggregate variables in the steady state
• Aggregate output:
Y / Nt = f ( k )
t
* *
Y = f ( k ) Nt
t
* *
• Aggregate consumption:
C = (1- s)Y = (1- s) f ( k ) Nt
*
t t
* *
• Both above measures grow at the rate of population
growth.
• Note that the aggregate capital stock also grows at the
growth rate of population.
Comparative statics of the steady state
• Increasing saving rate increases the steady
state per capita capital stock k*
• Increasing depreciation rate and/or
population growth rate decreases the steady
state per capita capital stock k*
• The above impacts on the output per capita
can then be deduced.
Transitional dynamics to the new
steady state
• Increasing saving rate
• Similar to the previous case.
Golden-rule level of capital per
worker(I)
• Def.: The maximum consumption per capita at
the steady state.
• Let c = C / N then the per capita
consumption at the steady state is
•c = f ( k ) - sf ( k ) = f ( k ) - (d + gN ) k (9)
* * * * *
Golden-rule level of capital per
worker(II)
• Golden-rule is determined by
max k* [ f ( k ) - (d + gN )k ]
* *
• Golden rule occurs at (FOC)
f '( kG ) = d + gN
*
(10)
Golden-rule level of capital per
worker(III)
• The saving rate implementing the Golden-rule
• Note first that the steady-state capital per
worker is determined by (8), in which s is
treated as exogenous.
• sf ( k ) = (d + g ) k -> k ( s)
* * *
(8)
N
• Substituting the above into the FOC for the
Golden-rule, (10), one can find the saving rate
• f '[ k* ( sG )] = d + gN (11)
f ( k)
(d + gN )k
sG f ( k)
k
*
k
Solow model with technological
progress (no population growth)
Capital accumulation (I)
• Aggregate capital accumulation
K t+1 - K t = sF ( K t , At N) - d K t
• Technological progress
At+1 = (1+ gA ) At
Capital accumulation (II)
• Dividing both sides by A_t N
K t+1 / ( At N) - K t / ( At N) = sF ( K t , Nt ) / ( At N) - d K t / ( At N)
• Using technological progress
(1+ gA ) K t+1 / ( At+1 N) - K t / ( At N) = sF ( K t , Nt ) / ( At N) - d K t / ( At N)
• Re-arranging
(1+ gA )( K t+1 / ( At+1 N) - K t / ( At N)) = sF ( K t , Nt ) / ( At N) - (d + gA ) K t / ( At N)
Capital accumulation (III)
• Capital accumulation per effective worker
• (1+ g )( k - k ) = sf ( k ) - (d + g ) k (12)
A t+1 t t A t
Steady state
• Def.: for some k such that the LHS of (12) is
zero, i.e., per effective worker capital stock
does not change over time kt+1 = kt
• There are two solutions when the RHS of (12)
is zero. One at k=0, which is unstable; the
other is at k > 0, which is stable. k is
* *
referred to as the steady state.
Stability of the steady state
• When k is small, the marginal product f’(k) is
large, so sf(k) > (delta+g_A) k. In this case, k
increases over time.
• When k is large, diminishing marginal product
implies that sf(k) < (delta+g_A) k. In this case,
k decreases over time.
• Note that the effective labor increases at the
rate of g_A. g_A serves a similar role to g_N in
the previous case.
Steady state capital per effective
worker
• In the steady state:
• sf ( k ) = (d + gA )k
* *
(13)
Steady state implications
• In the steady state, k*is constant, so output
per effective worker f ( k ) and consumption
*
per effective worker (1- s) f ( k ) are constant.
*
• In the steady state, to keep the capital per
effective worker constant, saving has to cover
both the depreciation and the increased
capital intensity due to technological progress.
Steady state implications
• Per capita measure:
Y / ( At N) = f ( k )
t
* *
Y / N = f ( k ) At
t
* *
• Similarly
C / N = (1- s) f ( k ) At
*
t
*
K / N = k At
*
t
*
Steady state implications
• Per capita output grows at the same rate as
technological progress.
• [Capital per capita and consumption per capita
also grow at the rate of technological
progress.]
Aggregate variables in the steady state
• Aggregate output:
Y / ( At N) = f ( k )
t
* *
Y = f ( k ) At N
t
* *
• Aggregate consumption:
C = (1- s)Y = (1- s) f ( k ) At N
*
t t
* *
• Aggregate capital stock
K = k At N
*
t
*
• All above measures grow at the rate of
technological progress.
Comparative statics of the steady state
• Increasing saving rate increases the steady
state per effective worker capital stock k*
• Increasing depreciation rate and/or g_A rate
decreases the steady state per effective
worker capital stock k*
• The above impacts on the output per effective
worker can then be deduced.
Transitional dynamics to the new
steady state
• Increasing saving rate
• Similar to the previous case.
Golden-rule level of capital per
effective worker(I)
• Def.: The maximum consumption per effective
capita in the steady state.
• Let c = C / ( AN) then the per effective
worker consumption at the steady state is
c• = f ( k ) - sf ( k ) = f ( k ) - (d + gA )k (14)
* * * * *
Golden-rule level of capital per
effective worker(II)
• Golden-rule is determined by
max k* [ f ( k ) - (d + gA )k ]
* *
• Golden rule occurs at (FOC)
f '( kG ) = d + gA
*
(15)
Golden-rule level of capital per
effective worker(III)
• The saving rate implementing the Golden-rule
• Note first that the steady-state capital per
effective worker is determined by (13), in
which s is treated as exogenous.
• sf ( k ) = (d + g ) k -> k ( s)
* * *
(13)
A
• Substituting the above into the FOC for the
Golden-rule, (15), one can find the saving rate
• f '[ k* ( sG )] = d + gA (16)
f ( k)
(d + gA )k
sG f ( k)
k
*
k
Solow model with technological
progress and population growth
Capital accumulation (I)
• Aggregate capital accumulation
K t+1 - K t = sF ( K t , At Nt ) - d K t
• Technological progress
At+1 = (1+ gA ) At
• Population dynamics
Nt+1 = (1+ gN ) Nt
Capital accumulation (II)
• Dividing both sides by A_t N_t
• Approximate
(1+ gA )(1+ gN ) @ 1+ gA + gN
• Re-arranging
Capital accumulation (III)
• Capital accumulation per effective worker
(1+ gA + gN )( kt+1 - kt ) = sf ( kt ) - (d + gA + gN )kt
•
• (17)
Steady state
• Def.: for some k such that the LHS of (17) is
zero, i.e., per effective worker capital stock
does not change over time kt+1 = kt
• There are two solutions when the RHS of (17)
is zero. One at k=0, which is unstable; the
other is at k > 0 , which is stable. k is
* *
referred to as the steady state.
Stability of the steady state
• When k is small, the marginal product f’(k) is
large, so sf(k) > (delta+g_A+g_N) k. In this case,
k increases over time.
• When k is large, diminishing marginal product
implies that sf(k) < (delta+g_A+g_N) k. In this
case, k decreases over time.
Steady state capital per effective
worker
• In the steady state:
• sf ( k ) = (d + gA + gN )k
* *
(18)
Steady state implications
• In the steady state, k*is constant, so output
per effective capita f ( k ) and consumption
*
per worker (1- s) f ( k )are constant.
*
• In the steady state, to keep the capital per
effective worker constant, saving has to cover
both the depreciation, the capital dilution due
to population growth and the increased
capital intensity due to technological progress.
Steady state implications
• Per capita measure:
Y / ( At Nt ) = f ( k )
t
* *
Y / Nt = f ( k ) At
t
* *
• Similarly
C / Nt = (1- s) f ( k ) At
*
t
*
K / Nt = k At
*
t
*
Steady state implications on per capita
variables
• Per capita output grows at the same rate as
the technological progress.
• [Capital per capita and consumption per capita
also grow at the rate of technological
progress.]
Aggregate variables in the steady state
• Aggregate output:
Y / ( At Nt ) = f ( k )
t
* *
Y = f ( k ) At Nt
t
* *
• Aggregate consumption:
C = (1- s)Y = (1- s) f ( k ) At Nt
*
t t
* *
• Aggregate capital stock
K = k At Nt
*
t
*
• All above measures grow at the rate of gA + gN
Comparative statics of the steady state
• Increasing saving rate increases the steady
state per effective worker capital stock k*
• Increasing depreciation rate and/or g_A rate
and/or population growth rate decreases the
steady state per effective worker capital stock
k *
• The above impacts on the output per effective
worker can then be deduced.
Transitional dynamics to the new
steady state
• Increasing saving rate
• Similar to the previous case.
Golden-rule level of capital per
effective worker(I)
• Def.: The maximum consumption per effective
worker in the steady state.
• Let c = C / ( AN) then the per effective
workera consumption at the steady state is
• c = f ( k ) - sf ( k ) = f ( k ) - (d + gA + gN ) k
* * * * *
• (18)
Golden-rule level of capital per
effective worker(II)
• Golden-rule is determined by
max k* [ f ( k ) - (d + gA + gN )k ]
* *
• Golden rule occurs at (FOC)
f '( kG ) = d + gA + gN
*
(19)
Golden-rule level of capital per
effective worker(III)
• The saving rate implementing the Golden-rule
• Note first that the steady-state capital per
worker is determined by (18), in which s is
treated as exogenous.
• sf ( k*
) = (d + g A
+ gN
) k*
-> k ( s)
*
(17)
• Substituting the above into the FOC for the
Golden-rule, (19), one can find the saving rate
• f '[ k* ( sG )] = d + gA + gN (20)
f ( k)
(d + gA + gN )k
sG f ( k)
k
*
k
Conclusions
No technological progress
• In the absence of technological progress,
• increasing saving rate
• can only increase the level of per capital
output
• It has no effect on long term economic growth.
Technological Progress
• Long run economic growth can only be
sustained by technological progress.
• In the steady state
• The rate of growth per capita output and per
capita consumption is the same as that of the
technological progress.