Asia-Pacific Economies Lec2

Chapter 2a

Review list

2.1 Explain the Harrod-Domar model of economic growth.

• The basic ideas of Harrod-Domar Model

Income(Y) =Saving(S) +Consumption

Growth rate (g) = (Yt+1-Yt)/Yt

=[saving(s)/capital-output efficiency ("θ" )]-depreciation of capital (δ)

It means that less consumption, more saving, and higher efficiency of the use of capital contribute to the economic growth. Therefore, population growth (η) can be added to the model and it reduces the rate of growth.

• Dynamic version of a simple Keynesian model

g=s/θ-η-δ

Growth rate (g) of per capita income is dependent on the rate of capital formation (s) and the efficiency of the use of capital (θ: capital-output ratio ---lower is better).

The population growth (η) is a negative factor of economic growth.

δ is the depreciation of capital stock.

• Weakness:

By assuming that the capital-output ratio (θ: efficiency) is constant, this model claims that there are constant returns to scale, no matter what the level of capital stock in the economy is (HDM). Output increases at the same rate as the inputs. The population growth maybe endogenous 内生的，.

2.2a Explain the Solow model of economic growth.

• Solow Model suppose that the larger the capital stock, the more likely it is that there will be diminishing returns to capital and focuses on the long run.

• That is, the output-capital ratio (1/ θ: efficiency of the use of capital) falls as capital increases because of a relative shortage of labor, which means the growth of the stock of capital is faster than the growth of labor.
• Diminishing marginal product: the marginal product of an input (C or L) declines as the quantity of the input increases.

• k^*/(y*)=s/(η+δ)

• In the steady state, the ratio of capital per capita to income per capita (capital-output ratio per capita: k/y) will be a positive function of a s (savings rate) and a negative function of η (population growth ratio) and δ (depreciation of capital).
• It means that the efficiency of the use of capital will decrease as savings rate increases and it increases as population grows.

• Conclusion:

• Convergence to a steady state level of per capita income occurs, despite differences in initial conditions. In steady, there is no deepening of capital, i.e., the amount of capital per capita remains unchanged from period to period. The total income growth rate is thus to be the same as the rate of growth of the population.
• The saving rate has no effect on the long-run growth rate of per capita output, which is zero.
• However, the saving rate affects the equilibrium level of per capita income. That means, the higher the rate of saving, the higher the steady state level of per capita income.

• The Solow Model (SM) & technical progress

• When technical progress is added to the Solow model in the form of more efficient workers, then it will result in growth in per capita income at the same rate as the rate of growth in worker efficiency.
• There is still a steady state, but it now relates to efficiency units of capital.

2.2b What is the steady state in the Slow model? Describe why the economy tends to the steady state.

Steady state means there is no deepening of capital, the amount of capital per capita remains unchanged from period to period. The ratio of (k/y) will be a positive function of s (saving rate) and a negative function of η（population growth rate）andδ(depreciation of capital).

[pic 1]

Because k*/y*=s/(η+δ) , so, sy=k(η+δ) →sy=k(n+d) we can draw a diagram above.

Left: k* is k0 ，sy＞ k（n+d）, △k＞0， k will increase.

Right: for example, k* is k1, sy＜k(n+d), △k＜0， k will decrease.

Only at k*, saving investment=required investment, sy=k(n+d), △k=0, △y=0, economy tends to the steady state.

2.2c Explain how per capita income in the steady state can increase in the Slow model?

• Because k*/y*=s/(η+δ), in the steady state, when theηdecreases, k*/y* will increase, y will increase.
• Increasing the saving rate can also increase y (per capita income).

[pic 2]

Because s is increasing, at k*, sy*＞k(n+d), k will increase until reaching to k**, so the per capita income in the new steady state will increase to the y**.

2.3. What are the main differences between the Solow and Harrod-Domar models?

• HDM: Growth among countries could easily diverge because the efficiency of the use of capital is constant.
• SM: Growth among countries would converge because the efficiency of the use of capital will decrease (that is, diminishing returns to capital, thus growth slowdown to a steady state rate).SM: Growth among countries would converge because the efficiency of the use of capital will decrease (that is, diminishing returns to capital, thus growth slowdown to a steady state rate).
• Another difference among them is population growth (h) and TFP.

• HDM: population growth is negative to per capita income increase (China). This model doesn’t say about TFP or labor.

• SM: it is positive because of diminishing returns to capital due to labor shortage compared with the growth of capital stock (advanced countries). This model adds technological progress as a factor of growth.

2.4. Explain the Power Balance theory of economic growth.

• Emphasized exploitation of poor “southern” economies by the rich industrial “northern” economies (the criticism of globalization).
• Deterioration of terms of trade of agricultural products in poor economies further aggravates the situation.
• This theory assumes that when incomes are low, countries (e.g. Africa) will not be able to save much. Moreover, because of poverty, it is difficult to improve productivity in agriculture. Thus, it is difficult to escape from a low income poverty situation.

• However, there are a lot of success case in Asia and South America.

• Key is political leadership (including good policies and education).

2.5a. Explain the structural approach of economic growth.

• A systematic shifts in output has been observed in the process of development in industrial countries and many developing countries.

[A shifting balance between the three major sectors of the economy – agriculture, industry and services.]