Weil Economic Growth Solutions Chapter 8.zip
Marnie Monteverde
Economic measurement with the GDP (output or national income) also includes potential problems; for instance, GDP also includes foreign investment and does then not represent wealth in that Country, but the foreign investment value. In addition, many aspects of economic wealth cannot be measured by GDP.
The source of a high total GDP value could be extensive population density, because more people are available as labour force. Therefore, when comparing countries with different population sizes it is advisable to compare the GDP per capita (GDP earned per capita). Despite these potential problems, GDP remains a rough estimate for comparing different living standards.
A further potential problem when comparing GDP values of different countries, is the influence of exchange rates, which are only determined by international traded goods. Therefore, converting different incomes in one exchange rate can create a wrong picture of the true purchasing value of a currency.
Therefore, the Purchasing Power Parity (PPP) provides a measurement of national income based on the relative purchasing power of a currency, measured by the price of a standardized basket, which contains a set of traded and non-traded goods and services.
The ratio scale (also: logarithmic scale) is mainly used for plotting variables (like growth rates), which grow over time, because spaces on the vertical axis correspond to proportionality differences in the variable. (e.g. 1:100) Whereas the common linear scale uses equal spaces on the vertical axis, corresponding to equal differences in the variable. The main difference between those concepts is visible when plotting a constant growing rate over time; plotted with the linear scale, the curve appears to be exponential (pp.11), plotted with a ratio scale, the curve becomes straight.
The difference between increased output due to business cycles or due to economic growth is mainly time related; Growth is characterized as a long-run trend, whereas business cycles can be defined as short term fluctuations, like recessions, i.e. deviations from the long run trend.
The total income inequality in the world is the result of two inequalities, first the difference in income between countries (Between country equality), which is in addition enhanced by inequality of per capita income within a single country (Within country inequality).
Only few data is available for period before 1820. Still, a significantly low GDP per capita growth rate is characteristic for an economy, which was driven by strong fluctuations due to the dependency on harvest conditions or armed conflicts. However, the income difference gap between countries is still very small. The world political order is dominated by rapidly progressing Western Europe expansion.
Worldwide income growth accelerates, with highly increasing average GDP growth per capita, but also the gap between country equality increases.(Compare: In 1820 the ratio of comparing wealth between rich and poor countries was 3:1 (3 times as rich), in 1998 the ratio increased to 19:1).
Chapter A introduced two measurements for economic performance; GDP and the Purchasing Power Parity (PPP). Whereas, when comparing income level, GDP has the risk of falsification due to exchange rate convergence, PPP measures solely the purchasing power of a currency.
Goods and services used for production rather than for consumption are defined as investment. The investment rate is therefore the fraction of income, which is further invested. A higher investment rate might explain more capital available per worker.
Productivity is the effectiveness, with which output is produced from a certain amount of inputs. Productivity differences can be caused by a technology difference. Technology is defined by the state of available knowledge about how to do (produce) things. Technological progress increases the produced amount of output with the same input (e.g. Productivity). The way in which available technology and inputs are actually used is called efficiency. Therefore:
The production function describes the method to generate output, by relating the amount of input factors used to the produced output. Input factor are either labour or capital. The productivity function of producing this summary, include the input factors of labour, in the form of the person writing the text and capital, e.g. the computers used or the printing machine. The output produced is obviously the summary.
Reverse causation describes the phenomenon that not X influences Y, but Y effects X. For example, the correlation between cars owned per family and the income, could be interpreted that having more cars will lead to higher income. However, the opposite is true; the two variables have a reverse causation.
The second chapter introduced the main topics of this literature; differences in accumulation of factors of production (Chapter C-E), differences in technology and efficiency (Chapters G-I) and proximate determinants of income differences (Chapters L-N). Furthermore, we introduced the method of the production function, a function that is used to describe output produced by using several input factors. The production function will be subject to closer analysis in Chapter G.
Return of Capital: Because of its productivity enhancing (Point 2) characteristics and Rivalry nature (Point 3) capital will create a return, which is often the incentive to carry out investments in capital.
As noted in Point 2 above, capital has the characteristics to increase productivity and therefore output. To assess the degree of that correlation, we will use the production function from chapter 2, which relates inputs used and output produced. The two production factors utilized are Labour (L) and Capital (K). Therefore the production function can be written as:
Constant returns to scale imply that the increase in output matches the increase in production factors used. E.g. if the double amount of total Capital and Labour input is used, the output will also be doubled.
where as A is a measurement for productivity, and takes values between 0 and 1, which describes the composition of how much capital is used in relation to labour (and vice versa). Therefore, a country with a higher productivity A (see Chapter B for definition of productivity), will have a higher output for a fixed amount of Capital and Labour.
Another implication of the marginal (diminishing) product of labour/capital is that a firm will set the wages (for labour) and rental rate (occurring cost when renting a capital good) in the competitive market equal to its MPL (marginal product of labour) or MPK. Because the wage represents the value added to the company, by adding one more labour unit. Is the wage lower than the marginal product of labour, an additional worker would increase the revenue for the firm more than he costs in form of labour. (The same reasoning holds for renting capital)
Nevertheless, can we use it to explain growth differences between two economies? In the steady-state level theory, the possibility is not incorporated that countries grow over a long period, because with the steady-state theory each country is supposed to reach its stable steady state equilibrium. Hence, the theory can only be applied if we assume that the countries are located in a convergence towards the steady state.
In order to examine what determines the investment rate we will first focus on the saving rate. The rate to which extend people save is determined by the opportunity costs of saving, e.g. forgone chance to consume now, thus also on how much they can afford to save and in addition it is dependent on voluntary individual choices. But the reason why savings rates differ can not purely explained by how much people can afford to save, e.g. live above the existence minimum. Factors which influence the saving rate and every economic model are either endogenous (from within the closed model) or exogenous (from outside the model). To reduce the complexity of the theory, we assume that saving is endogenous, thus not determined by flows of investment among countries. Therefore, all capital which is saved has to be used for domestic investment, it must hold; s= y (remember: y= fraction invested)
If saving is dependent on income, we can corporate the assumption that an economy can have two saving rates; one for high income, one for low income. Thus, that economy is able to have multiple steady-states (in this case two). If a country is stuck at the lower saving rate, the economy is in danger to be trapped there, because at the low savings rate, the economy has a lower income, which in turns determines the lower savings rate. Thus, the initial level of income determines to which steady-state the economy will move.
The main linkage between the population size, the population growth and economic growth is that an increase in the population will increase the input factor, labour but also the need for the supply of natural resources.
Population growth needs to be distanced from population size; a high growth rate is always dependent on the population base; if a small population size experiences an accelerated growth rate, the total population would be still small.
Population figures grew world wide in a significantly slow pace before the growth rates took off around 1800, from 0,09 % (from 1st century 18th century) to 1,8 % (19th century). Therefore, the high population growth rate trend is a rather recent phenomenon.
Thomas Malthus (1766-1834) observed that, without resource or health (fertility) constraints population will grow unlimited. Therefore, growth is only constraint by limiting circumstances, like poverty. In the inversion of that argument, the Malthusian model states that population growth reduces of income per capita, and will hence threaten chance of economic growth. Thus population growth will, after Malthus not improve the standard of living.
Part a) of the graphical model describes the influence of the population size on Income per capita. Since a high population size puts pressure on Income and resources, the relationship is negatively related; the higher the population size, the lower is the Income per capita. Thus, the curve is sloping downward.
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