Lecture 7 Handout 2023-2024 v1

faculty of economics economics.
econometrics and
and business finance
Macroeconomics for E&BE 2023-2024

Lecture 7
David Peng, Ph.D.

09 January 2024
Copyright 2021 Pearson Education Limited. All Rights Reserved

faculty of economics economics. econometrics and
Roadmap for today

Reading: Chapter 12
Block 1. Technological progress
Block 2. The Solow growth model (II)
Block 3. Wrap-up

1.1 Technological progress and the production function
§ Technological progress
§ Technological progress leads to increases in output for given
amounts of capital and labor.
§ The state of technology can be viewed as a variable that
tells how much output can be produced from given amounts of
capital and labor at any time.
§ If technological progress is taken into account, the production
function can be extended.

§ The extended production function
𝑌 = 𝐹 𝐾, 𝑁, 𝐴 .
(+,+,+)
𝐾: capital
𝑁: labor
𝐴: state of technology

More specifically,
𝒀 = 𝑭 𝑲, 𝑨𝑵 .
§ 𝐴𝑁: effective labor.

- Technological progress reduces the number of workers needed to
produce a given amount of output.
- If 𝐴 doubles, firms can produce the same quantity of output with

only half the original number of workers, 𝑁.

More specifically,
𝒀 = 𝑭 𝑲, 𝑨𝑵 .
§ 𝐴𝑁: effective labor.

- Technological progress increases the output that can be produced
with a given number of workers.
- If the state of technology 𝐴 doubles, it is as if the economy had

twice as many workers.

More specifically,
𝒀 = 𝑭 𝑲, 𝑨𝑵 .
§ Assumptions:
- Constant returns to scale: 𝐹 𝑥𝐾, 𝑥𝐴𝑁 = 𝑥𝑌, given 𝐴.
- Decreasing returns to capital and effective labor.


More specifically,
𝒀 = 𝑭 𝑲, 𝑨𝑵 .
In per effective worker terms:
𝑌 𝐾 𝐾
=𝐹 ,1 = 𝑓 .
𝐴𝑁 𝐴𝑁 𝐴𝑁

𝑌 𝐾
=𝑓
𝐴𝑁 𝐴𝑁
10

2.1 Interactions between output and capital
§ The effects of capital on output:
𝑌 𝐾
=𝑓
𝐴𝑁 𝐴𝑁
Higher capital per effective worker leads to higher output per
effective worker.
11

§ Output and investment:
𝐼 𝑌 𝐾
=𝑠 = 𝑠𝑓
Investment is equal to private saving.
12

§ Required investment: the investment needed to maintain a
constant level of capital.
§ Last week, assuming no technological progress and population
growth, the investment per worker needed to maintain a constant
level of capital per worker should be equal to depreciation per
worker:
𝐼!"#$%!"& 𝐾
=𝛿 .
𝑁 𝑁
§ This week, we allow for technological progress (increases in 𝐴)
and population growth.
13

§ Now, what is the required investment to maintain a given
level of capital per effective worker?
§ Amount 𝛿𝐾 is needed to replace depreciating capital.
§ Amount 𝑔! + 𝑔" 𝐾 is needed to maintain a constant level of 𝐾/𝐴𝑁.
- Denote the rate of technological progress by 𝑔! .
- Denote the rate of population growth by 𝑔" .
- Assuming that the ratio of employment to the population is constant,
then the number of workers grows at the rate of population (𝑔" ).
- 𝑔" 𝐾 is needed to provide capital for new workers, keeping 𝐴 fixed.
- 𝑔! 𝐾 is needed to provide capital for new effective workers due to
technological progress, keeping 𝑁 fixed.
14

§ Now, what is the required investment to maintain a given
level of capital per effective worker?
§ Together, the level of investment needed to maintain a given level of
capital per effective worker is:
𝐼#$%&'#$( = 𝛿𝐾 + 𝑔! + 𝑔" 𝐾
= 𝛿 + 𝑔! + 𝑔" 𝐾.
§ Equivalently, the amount of investment per effective worker needed to
maintain a constant level of capital per effective worker is:
𝐼#$%&'#$( 𝐾
= 𝛿 + 𝑔! + 𝑔" .
𝐴𝑁 𝐴𝑁
15

2.2 Dynamics of capital and output
§ Capital accumulation
§ Change in the capital stock equals investment minus required
investment.
𝐾 𝐾 𝐾
∆ = 𝑠𝑓 − 𝛿 + 𝑔! + 𝑔" .
- If investment per effective worker exceeds require investment per

effective worker, the change in capital per effective worker is
positive. Capital per effective worker increases.
- If investment per effective worker is less than require investment per
effective worker, the change in capital per effective worker is
negative. Capital per effective worker decreases.
16

§ Capital accumulation
§ Change in the capital stock equals investment minus required
investment.
𝐾 𝐾 𝐾
∆ = 𝑠𝑓 − 𝛿 + 𝑔! + 𝑔" .
§ The state in which output per effective worker and capital per effective
worker are no longer changing is the steady state:
∗ ∗
𝐾 𝐾
𝑠𝑓 = 𝛿 + 𝑔! + 𝑔" .
𝐴𝑁 𝐴𝑁
Note: The above is a generalization of the model we discussed last week, where 𝐴 = 1 and 𝑔! = 0.
17

18

§ Steady state
∗ ∗
𝐾 𝐾 𝑌 𝑌
= ⟹ = .
𝐴𝑁 𝐴𝑁 𝐴𝑁 𝐴𝑁
- 𝑔(/*+ = 0.
- 𝑔( = 𝑔* + 𝑔+ .
Because output and capital grow at the
- 𝑔(/+ = 𝑔( − 𝑔+ = 𝑔* . same rate 𝑔! + 𝑔" in steady state, the
steady state of this economy is also
- 𝑔,/*+ = 0.
called a state of balanced growth.
- 𝑔, = 𝑔* + 𝑔+ .
- 𝑔,/+ = 𝑔, − 𝑔+ = 𝑔* .
19

2.3 The effects of the saving rate
§ Changes in the saving rate do not affect the steady-state growth
rate of output (𝑌).
§ Changes in the saving rate do increase the steady-state level of
output per effective worker (𝑌/𝐴𝑁).
20

2.3 The effects of the saving rate
§ Changes in the saving rate do not affect the steady-state growth
rate of output (𝑌).
§ Changes in the saving rate do increase the steady-state level of
output per effective worker (𝑌/𝐴𝑁).
21

2.4 The golden-rule level of capital
§ The level of capital in steady state that maximizes consumption
per effective worker is the golden-rule level of capital.
∗ ∗ ∗
𝐶 𝐾 𝐾
=𝑓 − 𝛿 + 𝑔* + 𝑔+
§ First-order condition:
∗
d 𝐶 ⁄𝐴𝑁 d𝑓
= − 𝛿 + 𝑔* + 𝑔+ = 0
d 𝐾 ⁄𝐴𝑁 ∗ d 𝐾 ⁄𝐴𝑁 ∗
𝑴𝑷𝑲 = 𝛿 + 𝑔* + 𝑔+ .
22

Summary
§ In an economy with technological progress and population
growth, output grows over time.
§ In steady state, output per effective worker and capital per
effective worker are constant.
§ Output per worker and capital per worker grow at the rate of
technological progress.
§ Output and capital grow at the same rate as effective labor equal
to the growth rate of the number of workers plus the rate of
technological progress.
23
Block 3. Wrap-up
What is Macroeconomics?
§ Macroeconomics studies the economy of a county from a broad
perspective.
§ Macroeconomics studies the forces that influence the economy.
§ Macroeconomics is the study of output, unemployment, and
inflation.
24
Block 3. Wrap-up
The core question
§ What determine the level of aggregate output in an economy?
• Short run (week 1-3): The IS-LM Model
- Output is determined by how much is needed in the economy.
- Fluctuations are expected.
• Medium run (week 4-5): The IS-LM-PC Model

- Output is determined by how much the economy can produce.
- Output returns to the natural level.
• Long-run (week 6-7): The Solow Growth Model
- Output is determined by factors that lead to a sustained increase in the
output of an economy.
25
Block 3. Wrap-up GDP growth implies

more consumption,
Now you should understand… investment, and
employment.
OCTOBER 11 2022
Source: https://www.ft.com/content/30369662-554b-44b7-9f25-b87d5e13548d.
26
Block 3. Wrap-up
The head of the IMF
“warned of weak
Now you should understand… growth over the
next five years”.
OCTOBER 05 2023
Global Economy
World economy on course for ‘soft landing’ despite headwinds, IMF chief
says
Source: https://www.ft.com/content/a043b0aa-4eba-4fca-b0e3-e3cc74c1d812.
27
Block 3. Wrap-up However, a rapid

economic growth is
often associated with
Now you should understand… a hot labor market!
NOVEMBER 04 2022
Source: https://www.ft.com/content/1f3a7a41-daa8-49c5-ab51-3c0822421e40.
28
Block 3. Wrap-up And inflation!

The ECB has the
Now you should understand… mandate to maintain
price stability.
OCTOBER 31 2022
Source: https://www.ft.com/content/d783e38e-7a58-4285-b68a-55e357bb8c4b.
29
Block 3. Wrap-up
A tightening
Now you should understand… monetary policy is
often used to fight
SEPTEMBER 14 2023 inflation.
Source: https://www.ft.com/content/646d95e6-330f-4784-af76-3cf07f25c06f.
30
Block 3. Wrap-up
A tightening
Now you should understand… monetary policy is
often used to fight
OCTOBER 31 2023 inflation.
Source: https://www.ft.com/content/03ac15ba-76f7-4e31-b835-f9c6e5e9402e.
31
Block 3. Wrap-up
However, there are
complications:
Now you should understand… economic recession!
NOVEMBER 03 2022
Source: https://www.ft.com/content/c026994e-8d89-4e32-ac4d-571d6ccddce5.
32
Block 3. Wrap-up
However, there are
complications:
OCTOBER 24 2023
Source: https://www.ft.com/content/7d6015f9-3282-42a6-a3a9-192ec68458a0.
33
Block 3. Wrap-up
However, there are
complications:
DECEMBER 15 2023
Source: https://www.ft.com/content/4c32a65e-15a7-49df-a674-b88e2334f48d.
34
Block 3. Wrap-up However, there are

complications:
Now you should understand… economic recession
and unemployment!
NOVEMBER 03 2023
Source: https://www.ft.com/content/4a20ec7d-a01e-46f1-a00e-d4086cb53148.
35

complications:
Has inflation turned
Now you should understand… the corner?
JANUARY 06 2023
Source: https://www.ft.com/content/dc2b00ff-b7bb-4c2a-af44-ee08ab695ff4.
36

complications:
NOVEMBER 03 2023
Source: https://www.ft.com/content/c7e712e8-12be-4d25-82e5-e53bd3bb3311.
37

complications:
JANUARY 05 2023
Source: https://www.ft.com/content/4f4e0b97-697a-4a51-8ef9-f0068d27fa62.
38

complications:
OCTOBER 11 2023
Source: https://www.bloomberg.com/news/articles/2023-10-11/ecb-s-knot-says-
effects-of-inflation-shocks-are-now-waning.
39
Block 3. Wrap-up It seems that

inflation is getting
Now you should understand… close to the target
level of 2%.
NOVEMBER 30 2023
Source: https://www.ft.com/content/b7ef0e04-d86c-4545-a729-f5a82b28c375.
40
Block 3. Wrap-up
However, ECB is
Now you should understand… cautious!
DECEMBER 14 2023
Source: https://www.ft.com/content/848f4ca5-3a86-437f-bdaa-10d0d314b6e5.
41
Block 3. Wrap-up
And it seems that
Now you should understand… ECB is correct!
JANUARY 05 2024
Source: https://www.ft.com/content/be92c378-1ccb-4d8c-92fd-15fe4b51d906.
42
Block 3. Wrap-up
What do you
think?
Now you should understand…
DECEMBER 29 2023
Source: https://www.ft.com/content/3bdd81a0-e9d8-4f54-9ac5-8530d3fed1ad.
43
Block 3. Wrap-up
What do you
think?
Now you should understand…
JANUARY 04 2024
Source: https://www.ft.com/content/a68b2e5a-f104-4d05-8d94-b7dff0b18c12.
44
Block 3. Wrap-up
Now you should understand… What do you
NOVEMBER 04 2023 think?
Source: https://www.bloomberg.com/news/articles/2023-11-04/lagarde-says-ecb-will-
get-inflation-down-to-2-target-in-2025/.
45
Block 3. Wrap-up
Sustained economic
growth requires
Now you should understand… technological progress!
OCTOBER 28 2022
Source: https://www.ft.com/content/8038eac5-69a5-474f-a972-a23da089d1c3.
46
Block 3. Wrap-up
Sustained economic
growth requires
DECEMBER 14 2022
Tech start-ups
UK tech start-ups call for rethink to R&D cuts that ‘punish’ innovation
Source: https://www.ft.com/content/e5fa8d66-8fc1-488f-a82c-3c39bdc52a2c.
47
Block 3. Wrap-up
Sustained economic
growth requires
NOVEMBER 09 2023
Source: https://www.ft.com/content/2a0dbab1-f6a5-4432-8984-4112638dfdf0.
48
Block 3. Wrap-up “Low productivity, high

energy costs and lack
Now you should understand… of skilled labor are
Europe’s weaknesses”.
NOVEMBER 08 2023
Source: https://www.ft.com/content/39ec07ea-2ca6-4539-bf70-b0348347898f.
49
Block 3. Wrap-up
Free access to the Financial Times
https://webservices.ub.rug.nl/financialtimes/
50
Reminders
§ Final exam: January 16, Tuesday
§ Course evaluation: February 2-18 via Brightspace
§ Resit exam: April 8, Friday
§ Monetary Macroeconomics: 2nd year
§ Intermediate Macroeconomics: 3rd year (Economics track)
51
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faculty of economics economics.

Macroeconomics for E&BE 2023-2024

David Peng, Ph.D.

Copyright 2021 Pearson Education Limited. All Rights Reserved

Roadmap for today

Block 1. Technological progress

Block 2. The Solow growth model (II)

Block 1. Technological progress

Block 1. Technological progress

Block 1. Technological progress

§ 𝐴𝑁: effective labor.

- If 𝐴 doubles, firms can produce the same quantity of output with

Block 1. Technological progress

§ 𝐴𝑁: effective labor.

- If the state of technology 𝐴 doubles, it is as if the economy had

Block 1. Technological progress

- Constant returns to scale: 𝐹 𝑥𝐾, 𝑥𝐴𝑁 = 𝑥𝑌, given 𝐴.

- Decreasing returns to capital and effective labor.

Block 1. Technological progress

In per effective worker terms:

Block 1. Technological progress

Block 2. The Solow growth model (II)

Block 2. The Solow growth model (II)

Block 2. The Solow growth model (II)

Block 2. The Solow growth model (II)

Block 2. The Solow growth model (II)

Block 2. The Solow growth model (II)

- If investment per effective worker exceeds require investment per

Block 2. The Solow growth model (II)

Block 2. The Solow growth model (II)

Block 2. The Solow growth model (II)

Block 2. The Solow growth model (II)

Block 2. The Solow growth model (II)

Block 2. The Solow growth model (II)

Block 2. The Solow growth model (II)

- Fluctuations are expected.

• Medium run (week 4-5): The IS-LM-PC Model

Block 3. Wrap-up GDP growth implies

Block 3. Wrap-up However, a rapid

Block 3. Wrap-up And inflation!

Block 3. Wrap-up However, there are

Block 3. Wrap-up However, there are

Block 3. Wrap-up However, there are

Block 3. Wrap-up However, there are

Block 3. Wrap-up However, there are

Block 3. Wrap-up It seems that

Block 3. Wrap-up “Low productivity, high

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