@K.R.Bhattarai, Business School, University of Hull.

1

Economic Modelling

Lecture 2

Neoclassical Solow Growth Model

@K.R.Bhattarai, Business School, University of Hull.

2

Growth Rates in the UK Economy

-6

-4

-2

0

2

4

6

8

10

12

GGDP

Linear (GGDP)

@K.R.Bhattarai, Business School, University of Hull.

3

Diaparity in Per Capita Income Across the World

35620

340

24430

34100

12990

370

3580

1370

9340

19103600

1470

18530

7300

5101120

3020

193 990

27080

2360

980

34100

23550

0

5000

10000

15000

20000

25000

30000

35000

40000

Japan Nepal SauthAfrica

Ghana Albania UK Haiti USA NewZeland Benin Brazil Bolivia

US

Dol

lars

us-dollar ppp

Source: Hull University Network.Start/Applications/Economics/ World Development Indicators 2002

@K.R.Bhattarai, Business School, University of Hull.

4

Growth Miracles, Average Annual Growth Rate 1960-2000

4.99%5.21%

4.06%

5.72%

4.19%

5.40%

3.86%

5.89%

4.49%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

China

Hong K

ong,

Chin

a

Irelan

d

Korea,

Rep.

Japa

nM

alta

Portuga

l

Singa

pore

Thailan

d

Growth Rate of Per Capita Income Growth Miracle Countries

Source: Hull University Network. Start/Applications/Economics/ World Development Indicators 2002

@K.R.Bhattarai, Business School, University of Hull.

5

Growth Disasters, Average Annual Growth Rate 1960-2000

-0.75%-0.71%

-0.21%

-1.00%-1.11%

-0.79%

-1.61%

-0.24%

-1.04%

-0.30%

-1.26%

-1.80%

-1.60%

-1.40%

-1.20%

-1.00%

-0.80%

-0.60%

-0.40%

-0.20%

0.00%

CA

FR

P

Ch

ad

Gh

ana

Ha

iti

Mad

aga

sca

r

Nic

ara

gua

Nig

er

Se

neg

al

Sie

rra

Leo

ne

Ve

nezu

ela

, R

B

Za

mb

ia

Growth ate of Per Capita Income In Growth Disaster Countries

Source: Hull University Network.Start/Applications/Economics/ World Development Indicators 2002

@K.R.Bhattarai, Business School, University of Hull.

6

Solow Growth ModelProduction function with capital and labour as its inputs.Closed Economy without Government.

tLtKtAtY

tItCtY

Market clearing:

tsYtS

tKntI

tItS tIt

KtK 1

1

Household’s Saving Decision:

Investment requirement:

Closure rule in the model:

Dynamics: Capital accumulation:

Firm’s Production Function

@K.R.Bhattarai, Business School, University of Hull.

7

Y

K

Production Function

LAKY

Total capital stock

Tot

al o

utpu

t

@K.R.Bhattarai, Business School, University of Hull.

8

Intensive Production Function

k

L

K

L

LK

L

Yy

1L

Yy

L

KkPer capita capital

Per

cap

ita o

utpu

t

@K.R.Bhattarai, Business School, University of Hull.

9

Saving and Production Functions

k

L

K

L

LK

L

Yy

1

L

Yy

L

Kk

sksyS

@K.R.Bhattarai, Business School, University of Hull.

10

Saving and Investment Functions

L

Yy

L

Kk

sksyS

kni

@K.R.Bhattarai, Business School, University of Hull.

11

Per Capita Output and Per Capita Capital Stock in the Steady State

ky

L

Yy

L

Kk

sksyS

kni

0.5ks ks

Is and Ss

@K.R.Bhattarai, Business School, University of Hull.

12

Calculations of growth of Per Capita Output

Growth rate of Per Capita OutputL

Yy

LYy ggg

If Y grows by 5 percent, Labour grows by 2% then

03.002.005.0 LYy ggg

Similarly growth rate of Effective Per Capita Capital StockAL

Kk

LAKk gggg

01.002.002.005.0 LAKk gggg

If K grows by 5%, labour grows by 2% , technology grows by 2 % then:

@K.R.Bhattarai, Business School, University of Hull.

13

Growth Accounting

1LAKY

LKAY ln1lnlnln

LL

KK

AA

YY 1

LgKggYgYY

A 1

Take log of both sides:

Differentiate with respect to time :

@K.R.Bhattarai, Business School, University of Hull.

14

Growth Accounting

LgKggYgYY

A 1

Y

rKShare of capital:

Y

wL 1Share of labour:

Yg = growth rate of output

Ag = growth rate of technology or total multifactor

productivity

Kg = growth rate of capital input;

Lg = growth rate of labour input

If = 0.3 and Kg = 3% Lg =1% and ag

=2%, what is Yg ?

@K.R.Bhattarai, Business School, University of Hull.

15

time

UK 23550

34100US

UK Needs Higher Growth Rate to Catch the US in Per Capita Income

Per

cap

ita

inco

me

2002 2022

51383

guk=3.9%

gus=2.05%

33958

g=1.83%

@K.R.Bhattarai, Business School, University of Hull.

16

Time Taken to Multiply the Initial Income and to Bridge the Income Gap

a. Initial income 0y

b. Income in period t:gteyty 0

c. Double of the initial income 02

0ygteyty

d. n-times of the original income 00

nygteyty ngte

Take logs both sides of in (c ) or (d) gt2ln gtnln?2ln gt ?ln g

ntor

@K.R.Bhattarai, Business School, University of Hull.

17

Why Growth Rates Differ Across Countries?

Because of differences inCapital Stock (Buildings, Transportation and

Communication Networks, Machines)Labour input (Health and education of working

populations, their productive skills, knowledge)Technology (knowledge on how to combine inputs in

production; formula, design, software and management)

Economic Policy Natural resources?

@K.R.Bhattarai, Business School, University of Hull.

18

Reasons for Growth Miracle

Higher saving and investment rates.

Higher rate of technology adoption.

Better economic policy: close co-operation between the public and the private sector.

Realistic Trade and exchange rate policies.

Control of population growth rate.

@K.R.Bhattarai, Business School, University of Hull.

19

Reasons for Growth Disasters

Low Saving and Investment Rates.

Higher level of inflation and economic uncertainty.

Negative real interest rates.

High population growth rates.

Low exports and more imports and trade and balance of payment imbalance.

Weak Governments.

@K.R.Bhattarai, Business School, University of Hull.

20

Readings and References

Solow, Robert M. (1956) A Contribution to the Theory of Economic Growth, Quarterly Journal of Economics, pp.65-95.

Blanchard (10, 11)Mankiw (7)Burda Wyplosz (3) Miles and Scot (5-6)

Relevant web page:

http://www.bris.ac.uk/Depts/Economics/Growth/