ENDOGENOUS GROWTH

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ASIDE

OTHER ASPECTS OF THE

EXOGENOUS GROWTH
MODEL

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The Golden rule level of capital is the steady-state value
of k that maximizes consumption

Golden rule level of capital

Individuals care less about the amount of capital or output in the
economy. They care about the amount of goods and services they can
consume. Thus, a benevolent policymaker would choose the steady state
with the highest level of consumption. The Golden Rule level of capital,
denoted as k*gold, is steady-state value of k that maximizes consumption.
Mankiw, 9th ed., p 224.

y (n+g+δ) k

f(k)
c2
c s2∙f(k)
c1 s∙f(k)
s1∙f(k)

k
k1* k* k2*

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Dynamics of the model
Golden rule level of capital

f‘(k*gold) = n+g+δ [5]

Maximum consumption with sustainable growth is denoted as the point of

tangency between the slope of the break-even investment and the output
curve.

y (n+g+δ) k

f(k)
y* c
s∙f(k)
s f(k*)
y*gold

cgold sgold∙f(k)

s f(k*gold)

k
kgold* k*

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 generalization
At k < k*, actual investment is greater than break-even investment. The
neoclassical assumptions of the production function assure that eventually,
actual investment will be less than break-even investment, and such is that
case when k > k*.
At k < k*gold, an increase in the capital stock raises output more than
break-even costs, thus consumption rises. At k > k*gold, an increase in the
capital stock reduces consumption because the increase in output (i.e.,
denoted by slope, my(k)) is smaller than the increase in break-even costs
(i.e., denoted by slope, m(n+g+δ)k).

y (n+g+δ) k

f(k)
y* c
s∙f(k)
s f(k*)
y*gold At k > k*gold, a reduction in the
saving rate causes an immediate
cgold sgold∙f(k)
increase in consumption and an
equal decrease in investment. Over
s f(k*gold) time, as capital stock falls, output,
consumption, and investment fall
k together. Mankiw, 9th ed., pp 228 – 231.
kgold* k*

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Dynamics of the model
growth accounting

γY = αK(γK) + αL(γL) + SR [6]

Growth accounting for Solow-Swan model

Growth accounting answers how much growth do we attribute to

technological progress, population growth, and capital accumulation.
Mankiw, 9th ed., pp 270 – 278

Dynamics of the model

growth accounting

γY = αK(γK) + αL(γL) + SR
Solow residual
Growth accounting captures the directly observable contribution of factor
input growths (i.e., capital and labor growth) to output growth. The non-
directly observable contribution of technological progress unrelated to
changes in capital and labor is referred to as the Solow Residual, or Total
factor productivity (TFP) growth. This is the portion of increase in total
output which is not due to the growth of factor inputs.

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Brief case study of the solow residual
American technological boom

Total factor productivity growth captures the impact of intangible aspects

of human progress that allow both labour and capital to increase their
productivity. Thinking of the period 1990 to 2000, what has made the
US economy more productive and has increased welfare was not simply
the fact that firms have invested and bought computers, but rather that the
information revolution has allowed new machines based on computer
technology to be more productive and workers who use computers to
be more efficient.

EndoGENOUS GROWTH

Rebelo ak MODEL Sergio rebelo(1991),

has precursor on PaulRomer(1986)
The growth rate in a Rebelo AK economy is directly proportional
to the saving rate.
Rebelo, Sergio T. (1991): “Long-Run Policy Analysis and Long-Run Growth,”
Journal of Political Economy, 99(3), 500–521.

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Aggregate PRODUCTION FUNCTION
model

Y(t) = AK(t)
In contrast to a Solow-Swan model with a production function that
exhibits diminishing returns, the Rebelo AK model production function is
linear with respect to capital, and has constant (positive) technology.

Dynamics of the model

growth OF INPUTS
Similar to the Solow-Swan model, Rebelo also assumes that output is
divided between consumption and investment. Saving rate, population
growth, and depreciation rate are all constant.

𝐾 = I(t) – δK(t) [3.1]

𝐾 = sY – δK [3.2]

* For simplicity in notation, equation [3.2] as well as succeeding equations are written such that capital, capital growth, andoutput, are not
explicitly declared as functions of time. At this point, students should know which variables are time-bound.

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Dynamics of the model
growth OF INPUTS

𝑘= s∙Ak – (n+δ)k [4]

Fundamental equation of capital accumulation

The growth of capital accumulation per capita* is similar with the Solow-
Swan model, except that technology is constant, and f(k) is linear with
respect to capital. This small difference bears an important implication that
the general case of the Rebelo AK model is one without steady state.
* Unlike the Solow-Model, no effective labor is present and thus, equation of capital accumulation is in per capita terms only. Furthermore,
the capital accumulation equation in Mankiw (page 261) differs in that no population growth is accounted for in the AK model.

f(k) s∙Ak (n+δ) k

y (n+g+δ) k y

f(k)
y*
s∙f(k)
s*

k > > > > > > k

k*

Solow-swan Rebelo ak
Since the Rebelo AK production function is linear, savings never crosses
break-even investment line. This means that there is no steady state.

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Dynamics of the model
growth OF INPUTS

γK/L = sA – (n+δ) [5]

Capital per capita growth rate in a Rebelo AK model

Capital per capita growth rate increases with total factor productivity and
the saving rate, and declines with any component of break-even
investment costs. Because growth rate in this model is influenced by other
parameters, instead as being given, Rebelo AK model is an endogenous
growth model.

Solow-Swan RebeloAk
Y(t) F(K,AL) F(A,K)
Steady-state? Exists DNE
𝑘 s∙f(k) – (n+g+δ)k s∙Ak – (n+δ)k
𝐾/𝐿
𝐾/𝐿
= γK/L g (at steady-state) sA – (n+δ)

Since the Rebelo AK production function is linear, capital

accumulation per effective labor will expand at a constant
growth rate as long as sA > (n+g+δ).

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Growth of key variables at steady state
summary

Variable (x) K Y C
Growth (γx) n n n
Growth per
𝑥
effective labor γ (𝐴𝐿)
Growth per
capita γ (𝑥𝐿) sA – (n+δ) sA – (n+δ) sA – (n+δ)

generalizations

1 Absence of convergence
The Rebelo AK model does not predict convergence of
per capita output. Two economies with same technology
and savings rates will enjoy the same (per capita) growth
rate, regardless of their starting position.
This means that their per capita incomes will evolve in parallel and there will be no
tendency for “poorer” economies to catch up with the “richer economies.”

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generalizations

2 Absence of steady state

There is no steady state in the Rebelo AK model.
In the Solow-Swan model, a rise in the saving rate, for example, causes a level effect,
but not a growth effect, leading to a new steady state. In the Rebelo AK model, a
rise in the saving rate results to a growth effect, increasing the growth rate of output
per capita.

generalizations

3 eNDogeneity
Per capita growth rate of the Rebelo AK model is
influenced by other parameters other than technological
growth. It is not taken as a given.
By getting rid of diminishing returns, the Rebelo AK model can obtain continuous
growth of per capital income without the need to postulate an exogenous rate of
technological progress.

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 Other endogenous growth models

barr0 1990
rOMER 1986
lucas 1988
Public capital externalities Private capital externalities Human capital accumulation
e.g., tax-financed government services e.g., knowledge as input to production e.g., learning by doing, knowledge
that has increasing marginal productivity accumulation by research and
development activities
Barro, Robert J. (1990): “Government Spending in Romer, Paul M. (186): “Government Spending in a Lucas, Robert E. Jr. (1988): “The On the
a Simple Model of Endogenous Growth,” Simple Model of Endogenous Growth,” mechanics of economic development,”
Journal of Political Economy, 98(5), S103–S105. Journal of Political Economy, 94(5), 1002-1037. Journal of Monetary Economics, 22(1,), 3-42.
http://www1.worldbank.org/publicsector/pe/pfm http://www.dklevine.com/archive/refs42232.pdf http://www.sciencedirect.com/science/article/pii/
a06/BarroEndogGrowthJPE88.pdf 0304393288901687?via%3Dihub

Exercise. All of these statements are FALSE.

Determine and explain what makes the statements incorrect.
1. Under neoclassical assumptions, diminishing marginal returns on
factor inputs is both a necessary and sufficient condition.
2. In neoclassical growth models, capital accumulation is solely
determined by technological progress.
3. In neoclassical growth models, k > k*gold iff MPK < (n+g+δ).
4. Convergence hypothesis of neoclassical growth posits that
economies with currently low level of capital will in the long run
overtake those with already high level of capital.
5. Technological progress is endogenous on the Rebelo AK model.

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Exercise. Determine what is asked
Consider a neoclassical economy with a production function
Yt = K t 1/2 (A t L t )1/2
Saving and depreciation rates are constant at 16 and 10 percent, respectively.
Labor and technology stock grows as 2 and 4 percent per year, respectively.

1. Find the steady-state (i) capital stock per effective labor; (ii) output per
effective worker; (iii) growth rate of output per effective worker; and
(iv) growth rate of output.
2. Recompute your answers to above if growth rate of effectiveness per
worker doubles.

S M T W T F S

3 5
pset3 CH10
Ch 8-9 review

10 12
CH10 (cont.) Chapter
Quiz

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