RECAP OF PREVIOUS LECTURE

A. Given the following hypothetical income distribution, estimate the Gini coefficient

% Income % Population % of Population Richer Score

.10 .20 .80 .10*(.20+2*(.80) = .18
.20 .40 .40 .20*(.40+2*(.40) = .24
.30 .60 0 .30*(.60+2*(0) =     .18
.20 .80 Score:                       .60
.10 1.00
.10 Gini Index = 1 - .60 = .40 or 40 %  inequality
1.00

B. Suppose Lorenz curve is expressed as X4.2 compute the Gini coefficient. 

Formula:  1 - 201Lxdx

    1 – 2 01X4.2 = 1 – {2 [15.25.2 ] – 2[05.25.2]} = 1 - .3846 = Gini coefficient = .6153 0r

61.53 % inequality

A. Rostow Linear Stages Growth Model  (we are done with this model)

B. Harrod- Domar Growth Model

 This model is founded on the idea that population growth is the source of savings which
provide the funds for investment. Please note that saving is an act of putting money in
the banks or financial intermediaries in order to earn interest income, while investment
is an act of borrowing.

 Hence, higher rate of savings means higher rate of investment which will help sustain
growth as the theory suggest.

 Productivity of investment is evident by lower capital to output ratio. For example, 8

units of capital is needed to produce 1 unit of output is less productive compared to 3
units of capital to produce1 unit of output.

 Economic growth therefore is dependent upon the amount of labor and capital which
expresses a production function: Y = f(K, L), where K = is capital and L is the amount of
labor. Dividing both sides of equation by Labor (L) = YL= f(KL, 1) where YL=output per
worker and KL=capital to labor ratio. Hence, Economic growth per worker is
dependent upon capital to labor ratio.

 Since capital to output ratio is equal to ∆K∆Ychange in capital per unit change in
output=which is also equal to change in savings per unit change in output ∆S∆Y .
 Since economic growth rate is equal to  ∆YY= ∆K∆Y= I∆Y. Hence, ∆YY x I∆Y= IY= SY .
Suffice it to say, equilibrium or steady state is reach at I = S.

 Harrod-Domar Model is practically in support of Keynesian model in principle.

Limitations of Harrod-Domar Model

 Attempt to increase savings rate in low income countries is difficult because low
marginal propensity to save (MPS)
 Poor countries lack financial system to mobilize savings and investment
 Reducing capital to output ratio in poor countries is difficult because of weak human
capital
 R&D in poor countries are inadequate and heavily unfunded
 Increase in capital  is good only when economy starts to grow dynamically

Robert Solow Growth Model

 Solow’s growth model is built upon the assumption that production function is at
constant return to scale
 For example, Y = f(K13 L23). Note that adding the exponents is equal to one which
means constant return to scale. Do you think so in real life? 

 Dividing both sides of equation by labor we get:

YK=f(KK , L) = YK=f(L, 1)

Actual growth rate = Capital to output ratio = ∆K∆Y= ∆S∆Y= ∆Yy= ∆K∆Y= ∆K∆Y=
I∆Y=S∆Y
S = 1 equilibrium (stady state)

Limitations of Harrod-Domar Model

 Increasing saving rate in low income countries is difficult because of low propensity to
saving
 Poor countries lack financial system
 Reducing capital-output is difficult because of weakness in human capital
 R& D is often is often under funded
 Increase in capital is good only if economy starts to grow dynamically

Solow Growth Model

This model I founded on production function  y = f(K, L)

Y = GDP per worker

K = cspital per worker
D = depreciation rate
S = savings rate
In a closed economy GDP (Y) = C + I; note that S  = 1

C = consumption per worker

I = investment per worker
 I – sy
Plug this into C+I 

Y = C +sy = 1 – s (y)

Suppose:

Y= K1/3

Dr = depreciation rate = .02

S = .10

Sy = dK when ΔK=0 

sK1/3 = dK

.10K13 =  .02K

.10K1/3.02= .02K.02

5K13 = K

5= KK1/3

K23 =  5

K = 2/35

Steady State capital to labor ratio (K) = 2.9240

Steady state output per worker

Y=K1/3

Y=2.92401/33= 1.4299

Steady state consumption

C ( 1 – s) y = ( 1 - .10) (1.4299) – 1.28697

Steady state investment 

I - sy = .10 (1.4299) = .14299

Y = C + I  = 1.28697 + .14299 = 1.4299