Lecture 1 - Economic Growth

Mok W S

August 14, 2023

Reference

▶ Chapter 7, Economic Growth: Malthus and Solow. Williamson

Highlights

We will start this course with economic growth which is essentially

the long run behavior of the economy. We first note the empirical
behaviors of key economic variables of the US economy and cross
country observations. We then proceed to analyse 2 key growth
models: the Malthusian and the Solow model and critique them.

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Natural Log of Real GDP Per Capita (US economy)

We decompose log of Real GDP (Y) per capita into a trend component and fluctuations
around a trend.
Long Run(Economic Growth) is concerned with the trend element in Y (Aggregate and
per capita) and Short Run (Business Cycle) is concerned with the fluctuations around the
trend.
Except for certain periods (prior to 1965 and 2009-2015), average growth rate of per
capita real GDP is about 2% per annum. Note: natural log translation into % points.
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Cross Country Observations - Real Income Per Capita vs
Investment Rate

Using cross country observations, the scatterplot shows that real

income per capita and investment rate of countries are positively
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Cross Country Observations - Real Income Per Capita vs
Population Growth Rate

Real income per capita and population growth rate are negatively
correlated.
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Cross Country Observations - Growth Rate in Per Capita
Income vs Level of Per Capita Income

There is no tendency for rich countries to grow faster than poor countries and vice versa.
Rich countries are more alike in terms of growth rate than are poor countries. (note
variance)
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Growth Models - an outline
Malthusian Model
▶ Models labor growth as the driver of growth in an economy with land
and labor as the production factors.
▶ Labor(population) growth is determined by the standard of living
(measured by per capita consumption).
▶ Applies to agricultural economy - pre-industrial revolution period
(1800).
Solow Model
▶ Models the growth of capital per worker as the driver of growth in an
economy with labor and capital as the production factors.
▶ Investment rate is exogenously set.
Endogenous Growth Model (will not be covered)
▶ Models the acquisition of human capital (education and training) as
the driver of economic growth.
▶ Human capital acquisition is used to explain persistent differences in
growth rates between countries.
We will evaluate the models in relation to the empirical observations
discussed previously.
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The Malthusian Model of Economic Growth
Model Prediction
▶ Technology progress has no impact on standard of living as measured
by per capita income or consumption.
▶ The reason is that technology progress results in an increase in income
which will increase the population to the point that income per capita
returns to its initial steady state.
Production function has land (L) which is fixed and labor(N) as
inputs.
Y = zF (L, N)

▶ Y is the aggregate output of the economy and z is a measure of the

level of technology(also known as Total Factor Productivity).
▶ We shall use capital letters to denote aggregate quantities and small
letters e.g. y, f, c to denote per capita quantities.
▶ The usual restriction applies on the production function. It is
increasing in the variable production factors, N and is concave in N
such that FN > 0 and FN,N < 0* given that L is fixed.
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The Malthusian Model of Economic Growth

The population growth is characterised by the following:

N′
= g (c)
N

▶ Population growth, g(c) is increasing in the standard of living measured

C
by c = N .
▶ g(c) is also concave in c.
▶ In equilibrium, C = Y = zF (L, N) =⇒ g (c) = g (z F (L,N)
N ).
▶ With a constant return to scale function F(.), we can also write F(L,N)
as NF( NL ,1) or Nf (l). (to be inline with Williamson)

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Solving for Population Evolution

We rewrite the equation for population as

F (L, N)
N ′ = g (z )N
N
The gradient of curve is decreasing in N as N becomes large such that
N’ is concave in N. =⇒ a steady state equilibrium, N* exists.

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Equilibrium Evolution of Population

Note : y axis is N’ and x axis is N.

Transition from below N* and above N* will converge to N*. (To be
illustrated in class)
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Solving for Population Evolution

Steady state is given by

N ∗ = g (c ∗ )N ∗ =⇒ g (c ∗ ) = 1

Steady-state c* is independent of any other factors!

For example, if z(productivity) increases, c* remains the same
although aggregate C* increases and N* increases.

c ∗ = y ∗ = zf (l ∗ )

L
C ∗ = Y ∗ = zF (L, N ∗ ) = zN ∗ F (
, 1) = zN ∗ f (l ∗ )
N∗
z increase is offset by a decrease in l* (because N* increases.) Note
all small letters denote per worker or per capita quantitites (i.e.
divided by N).

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Analyzing the effect of z on the steady state - I

Fig b denotes the steady state condition.

Fig a denotes the per capita production function zf(l) which is concave in l. c=y=zf(l).
As z increases, zf(l) shifts up but c* stationary implies that l* has decreased to l1 .
If Fig b is replaced by one with N’ and N axis, you can show that N* increases but will
stay on the 45 degree line.
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Analyzing the effect of z on the steady state - II

Transition dynamics will be illustrated in class.

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Transition to Steady State when z increases

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Population Control in the Malthusian Model

Given that productivity increase does not improve standard of living,

what can be done?
Population or birth control is a solution : if attitudes towards smaller
family sizes improve favorably, steady state consumption per capita
can increase.

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Population Control in the Malthusian Model

Population control alters the steady state relationship between population growth and
per-capita consumption by shifting g(c). Note g1 (c) changed to g2 (c) represents
functional change or attitude changes.
In the long run, per capita consumption increases and living standards rises if population
growth function is shifted down.

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Critique of the Malthusian Model
The model provides a good explanation for pre 1800 growth facts in
the world. (Land as fixed factor of production) - No significant
improvement of average living standard despite growth in population,
production and producivity.
Post 1800, despite advances in healthcare which increases life
expectancy, rich countries experience population declines. g(c) is not
increasing in c. This can be attributed to the cost of raising children
and the opportunity cost of time spent at home raising children
versus working for women.
The role of capital accumulation is essential in the current context of
post industrial revolution. Capital is not fixed in supply, can be
accumulated to increase production capacity.
Population control policies can create issues with birth rate falling
below replacement rate and increasing life expectancy due to
healthcare advances. This causes strains on government budgets.

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