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2.3.2 Balanced Growth: α ∗ Y K - (2.14) /K /K

1) The document discusses the conditions necessary for sustained economic growth, noting that sustained growth in capital alone will eventually lead to diminishing returns and low rates of return that households won't accept. 2) It then introduces the concept of a "balanced growth path" where real interest rates, labor input, and the growth rates of output, consumption, investment and capital are all constant over time. 3) For an economy to be on a balanced growth path, the growth rate of technology must intrinsically determine the constant growth rates of other macroeconomic variables.

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Akash Kumar
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37 views2 pages

2.3.2 Balanced Growth: α ∗ Y K - (2.14) /K /K

1) The document discusses the conditions necessary for sustained economic growth, noting that sustained growth in capital alone will eventually lead to diminishing returns and low rates of return that households won't accept. 2) It then introduces the concept of a "balanced growth path" where real interest rates, labor input, and the growth rates of output, consumption, investment and capital are all constant over time. 3) For an economy to be on a balanced growth path, the growth rate of technology must intrinsically determine the constant growth rates of other macroeconomic variables.

Uploaded by

Akash Kumar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Now, take equation (2.

9), the optimality condition for a firm’s use


of capital, and divide both sides by Kt :
α ∗ Yt
Kt
= rt . (2.14)
Holding labor and technology fixed, as capital increases Yt/Kt
declines. At some point, α ∗ Yt/Kt will be less than the rental rate
on capital rt . Since the rental rate is linked to households’ required
after-tax return on savings (discussed later in this chapter), at some
point households stop investing in capital because the rate of return
on additional investment is too low.
To sum up: sustained growth in the per-capita labor input is impossible,
and sustained growth in the per-capita stock of capital, holding
labor and technology fixed, yields after-tax rates of return on capital
that are too low for households to accept. Thus, sustained growth
in real GDP and real wages can only be achieved through sustained
growth in technology.
2.3.2 Balanced Growth
In the postwar period, the US has been on a “balanced-growth path.”
On a balanced-growth path,
• real interest rates (the pre-tax pre-depreciation marginal product of
capital) are trendless;
• the per-capita labor input is trendless;
• output, consumption, investment, and capital all increase at the
same rate;
• the rate of growth of output, consumption, investment, and capital
is intrinsically linked to the rate of growth of technology.
In Chapter 1, we showed that the consumption-output and
investment-output ratios have been trendless, or close to it, sincewhere δ is the constant depreciation
rate on capital. Substituting in the
capital-stock accounting equation into the GDP accounting equation
yields:
Yt = Ct + Kt+1 − Kt(1 − δ).
Divide both sides by Yt and use the trick that 1/Yt = (1/Yt+1) ∗
(Yt+1/Yt ):
1 = Ct
Yt
+
_
Kt+1
Yt+1
__
Yt+1
Yt
_
−
_
Kt
Yt
_
(1 − δ). (2.15)
In balanced growth, the capital-output ratio (Kt+1/Yt+1 and Kt/Yt ),
the growth rate of output (Yt+1/Yt ), and the depreciation rate (δ)
are all constant. Since the number 1 and the depreciation rate δ are
also constants, equation (2.15) shows that the consumption-output
ratio must also be constant in a balanced growth environment. Now
return to the GDP accounting equation and divide both sides by Yt
such that:
1 = Ct
Yt
+ It
Yt
.
Since the consumption-output ratio is a constant, the investmentoutput
ratio must also be constant.
Summing up, in a balanced-growth environment, interest rates are
trendless, implying that capital and output increase at the same rate
(which is determined by the rate of growth of technology).When capital
and output increase at the same rate,GDPaccounting implies that
the consumption-output and investment-output ratios are constant

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