lecture 17 growth theory

7/28/2019 Lecture 17 Growth Theory

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Growth Theories

Three main strands of Growth Theory have

developed over time, each building upon and

replacing the previous theory:

1. Classical Growth Theory (Malthus)

2. Neoclassical Growth Theory (Solow)

3. New Growth Theory (Romer, Lucas)


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Growth Theories

Classical Growth Theory

Classical growth theory is the view that real GDP growth

is temporary and that when real GDP per person rises

above the subsistence level, a population explosion brings

real GDP per person back to the subsistence level.

Therefore, Economics = the Dismal Science


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Growth Theories

The basic Classical idea

There is a subsistence real wage rate, which is the

minimum real wage rate needed to maintain life.

Advances in technology lead to investment in new capital.

Labor productivity increases and the real wage rate rises

above the subsistence level.

When the real wage rate is above the subsistence level,the population grows.

Population growth increases the supply of labor, which

lowers the real wage rate.


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Growth Theories

The population continues to increase until the real wage rate has beendriven back to the subsistence real wage rate.

At this real wage rate, both population growth and economic growthstop.

In fact, these predictions which may have seemed plausible during the18th and early 19th centuries, when this theory was developed, are notconsistent with the actual growth experiences of modern industrialeconomies. (Though it may have some bearing on those Africaneconomies that seem to have such difficulty maintaining growth.)

Contrary to the assumption of the classical theory, the historicalevidence is that population growth rate is not tightly linked to incomeper person, and population growth does not drive incomes back downto subsistence levels.


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Growth Theories

Whats wrong with the theory?

Contrary to the assumption of the classicaltheory, the historical evidence is that populationgrowth rate is not tightly linked to income perperson, and population growth does not drive

incomes back down to subsistence levels.


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Growth Theories

Figure 9.7 illustrates theClassical growth theory.


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Growth Theories

Neoclassical Growth Theory

Neoclassical growth theory is the proposition that real

GDP per person grows because technological progress,

which increases the productivity of capital (and labor),

increases investment demand, inducing a level of saving

and investment that makes capital per hour of labor grow.

The growth in technology and capital per hour of labor

combine to increase labor productivity and real GDP per

capita.

Growth ends only if technological change stops.


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Growth Theories

The neoclassical economics of population growth (vs.the classical economics of population growth)

The neoclassical view is that the population growth rate isindependent of real GDP and the real GDP growth rate.

The population growth rate equals the birth rate minus thedeath rate.

The birth rate is determined by the opportunity cost of awomans time.

As womens wage rates have increased, the opportunitycost of having children has also increased and the birthrate has fallen.


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Growth Theories

The death rate is determined by the quality and availability

of health care.

As the quality and availability of health care has improved,

the death rate has fallen.The fall in both the birth rate and the death rate have offset

each other and made the population growth rate

independent of the level of income.


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Growth Theories

The basic neoclassical idea

Technology begins to advance more rapidly.

New profit opportunities arise.

Investment demand increases.

Investment and saving increase.

As technology advances and the capital stock grows, real

GDP per person rises.Diminishing returns to capital per hour of labor lower thereal interest rate and eventually growth stops unlesstechnology keeps on advancing.


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Growth Theories

Figure 9.8 illustratesneoclassical growth

theory.


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Growth Theories

New Growth Theory

New growth theory holds that real GDP per person grows

because of choices that people make in the pursuit of

profit and that growth can persist indefinitely.

The theory emphasizes that

In a market economy, discoveries result from choices

Discoveries bring profit and competition destroys profit Discoveries are a public capital good

Knowledge is not subject to diminishing returns


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Growth Theories

Figure 9.9 illustrates

new growth theory.


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Growth Theories

Figure 9.10 summarizes the ideas of new growth theory asa perpetual motion machine.

lecture 17 growth theory

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