ECON1002
Introductory
Macroeconomics
Week 9 Lecture
Semester 2,
2023
School of Economics
The University of Sydney Page 1
Lecture 8
In this lecture, we aim to answer the following
questions
What is a long-run economic growth?
What are the historical facts about growth?
What determines per capita income and living
standards?
Does growth worsen economic inequality?
What is the production function approach to
growth?
How do we measure the contributions of
different factors of production to
long-run growth?
The University of Sydney Page 2
Long-run Growth vs Business cycles
Using AD-AS model
LRAS1955 LRAS2019
SRAS SRAS
AD02019
AD 0
1955
AD12019
AD 1
1955
Y’1955 Y*1955 Y’2019 Y*2019 Y
The University of Sydney Page 3
Economic Growth over the Millennia
GDP per person (US$'000s, 1990 prices)
30
Western
25 Countries
20
15
10
World
5
Asia (not Japan)
Africa
0
0 1000 1500 1600 1700 1820 1870 1913 1950 1973 1998
Source: Angus Maddison: The World Economy. A
Millennium Perspective (OECD,2001)
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Some Historical Growth Facts
1 billion people at the beginning of the 20th century, now
more than 7 billion on earth.
1 billion people still living on less than US$2 (in 1985
prices) per day – vast majority in Africa.
Not everyone is better off (In fact, a huge increase in
population (due to pop growth) living in absolute poverty!)
Some countries (East Asian NIEs) experienced ‘growth
miracles’ while some others (sub-Saharan African
countries) ‘growth disaster’.
Growth is probably the best way to get out of the vicious
circle of poverty.
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A Tale of Two Koreas
GDP per capita
The Importance of Institutions:
14000
Legal Institutions 12000 South Korea
- Are laws reliable and credible?
10000
- Do laws protect innovators?
1996 US dollars
- Is the judicial system efficient? 8000
- Are good incentives encouraged?
6000
Market Institutions 4000 North Korea
- Capitalistic or central planning?
2000
- Encourage monopoly or competition?
- Good governance and supervision 0
matter! 1950 1960 1970 1980 1990 1998
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Costs of Growth
Does growth worsen environmental quality?
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Growth and Income Distribution
Does growth worsen income distribution?
For an individual country after a sustained growth
The University of Sydney Source: Quah, D. (2007) Page 8
Growth and Income Distribution
Does growth worsen income distribution?
“Emerging twin peaks in the cross-country income
distribution”
Source: Quah, D. (2007)
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Growth Rate and Living Standards
Importance of Growth Rates
Levels of Real GDP Average
Growth Over a long period of time, a
per Capita small difference in the rate of
Rate economic growth makes a
Country 1870 1950 1996
huge difference in a country’s
Australia 3,123 5,931 15,076 1.3% standard of living
Canada 1,347 6,113 17,453 2.1%
Japan 618 1,563 17,346 2.7%
UK 2,610 5,651 14,440 1.4%
US 2,247 8,611 19,638 1.7%
(Values are expressed in US$ in 1985 US prices)
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Growth rate and Living Standards
Imagine that the US grew at the historical average of India’s growth
over 1870-2000. Small changes in growth rates can make a big
difference to living standards.
US real per capita y –
actual growth (1.8% pa)
US real per capita y –
India’s growth (0.8% pa)
Source: Barro and Sala-I-Martin 2004
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Growth rate and Living Standards
t
% Y
Yt Y0 1
100
YEAR 1.8% 1.5% 1.2%
0 $100 $100 $100
5 $109.33 $107.73 $106.15
50 $244.00 $210.52 $181.56
100 $595.36 $443.20 $329.65
‘The rule of 70’: If a variable grows at x% a year, then it will
take approximately 70/x years for the variable to double.
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Production Function approach
Technology
Managerial
Labour
Expertise
Skills Output
Capital
Everything
Primary else
Secondary (TFP)
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Production Function
Cobb-Douglas production function
A production function: numerical example
0.5 0.5
Y 2 K L
General functional form: widely used in economics
1
Y AK L
A is called Total Factor Productivity (secondary factors of production)
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Production Function
1
Y AK L
Exhibits Constant Returns to Scale
Any proportionate increase in the primary
factors (K, L) leads to the same
proportionate increase in output.
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Diminishing Marginal Productivity
The production function exhibits both
Constant returns to scale (when all inputs are
varied)
Diminishing Marginal Productivity of Capital and
Labour (when one of the inputs is held constant)
proof
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Per capita Production function
1
Consider the Cobb-Douglas form
Aggregate Production function:
Y AK L
Per capita Production function:
where 0< < 1.
The per capita function exhibits diminishing marginal productivity in
k. An increase in k leads to a smaller increase in y as k increases!
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The Per Capita Production Function
y
production
y1 function
Question: Will
y0 growth ever stop?
k
k k
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Factors Affecting Growth
This is a first look – much more detail coming soon
Y Y N
POP N POP
Per capita Average labour Share of the
GDP productivity population employed
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Factors Affecting Growth
N/POP GDP per capita and Average Productivity
0.64
0.62
0.6
0.58
0.56
0.54
0.52
Feb-78
Feb-80
Feb-82
Feb-84
Feb-86
Feb-88
Feb-90
Feb-92
Feb-94
Feb-96
Feb-98
Feb-00
Feb-02
Feb-04
Feb-06
Feb-08
Feb-10
Source: FRB of St Louis.
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Factors Affecting Growth
Human Capital
Gary Becker
(Nobel prize
winner 1992)
Training, talents, education and skills
- cannot be separated from the
individuals concerned
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Factors Affecting Growth
Physical Capital
Workers + no capital = no output
Workers + capital = output
Skilled workers + capital = more output
Skilled workers + better capital = even
more output
Capital formation requires S and I.
The University of Sydney Page 22
Growth Accounting
How do we calculate what components of the production
function most contributed to the observed growth?
The aggregate production function with technology can be
expressed as
𝑌=𝑨 𝐹(𝐾 , 𝑁)
This technology denoted A captures total factor
productivity (TFP) and is neutral with respect to inputs.
How does total output Y change, if we vary K, N, assuming
A is constant?
Y = (Y/ K) × K (if N = 0)
The University of Sydney Page 23
Y = (Y/ N) × N (if K = 0)
Growth Accounting
Now let both inputs change, then the total change in
output
Y = MPK × K + MPN × N
Writing it as
𝑌 ( 𝑌 ) (
Δ𝑌 𝑀 𝑃 𝐾 × 𝐾 Δ 𝐾 𝑀 𝑃 𝑁 × 𝑁 Δ 𝑁
=
𝐾
+
𝑌 𝑁 )
Assume further:
Markets are perfectly competitive, implying factors
of production are paid their marginal product (ie, MPN
= w and MPK = r).
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Growth Accounting
Then, we can write it as
Δ𝑌 Δ𝐾 Δ𝑁
=𝛼 +(1− 𝛼)
𝑌 𝐾 𝑁
where and (1- ) are capital’s and labour’s share of
output, respectively.
Now allowing for a change (growth) in A, then it becomes
Δ𝑌 Δ 𝐴 Δ𝐾 Δ𝑁
= +𝛼 +(1 −𝛼)
𝑌 𝐴 𝐾 𝑁
This is called the Growth Accounting equation.
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Growth Accounting
What is A/A?
– Growth in total factor productivity
(TFP), also called the Solow
residual, which measures the rate
of technical progress.
– Is the Solow residual a good
measure of technical progress?
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Contributions of Capital, Labour and TFP:
OECD
1947-73 (Barro and Sala-i- Martin Economic Growth)
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Contributions of Capital, Labour and TFP:
OECD
1960-95 (Barro and Sala-i- Martin Economic Growth)
The University of Sydney Page 28
Case Study: East Asian growth 1966 –
1996
East Asian 'Tigers': Hong Kong, Singapore, South
Korea, and Taiwan had remarkably high economic
growth
HK Singapore S. Korea Taiwan
Y/Y 5.7 6.8 6.8 6.7
A/A 2.3 0.2 1.7 2.6
a K/K 3.4 6.6 5.1 4.1
+ (1-) N/N
Source: Alwyn Young (1995) QJE
What were the driving forces of growth?
Can economic theory explain this?
The University of Sydney Page 29