Topic 6

Economic Growth (Part I)

Lecturer: A/Prof Stella HUANGFU

S1, 2025
Chapter 10
The Facts of Growth

2025 2
 Chapter 10 Outline
The Facts of Growth
10.1 Measuring the Standard of Living

10.2 Growth in Rich Countries since 1950

10.3 A Broader Look across Time and Space

10.4 Thinking about Growth: A Primer

3
 The Facts of Growth

• Growth is the steady increase in aggregate

output over time.

• We now shift our focus from economic fluctuations

and the determination of output in the short and
medium run to growth and the determination of
output in the long run.

4
 Figure 10.1 Australian GD P and GDP per
person since 1901

The figure
shows the
enormous
increase in
Australian
output since
1901, by a
factor of 40.

5
 10.1 Measuring the Standard of
Living
• We care about growth because we care about the standard
of living.

• Output per person, rather than output itself, is the

variable we compare over time or across countries.

6
 10.1 Measuring the Standard of
Living
• We need to correct for variations in exchange rates and
systematic differences in prices across countries.

• When comparing the standard of living across countries,

we use purchasing power parity (P P P) numbers which
adjust the numbers for the purchasing power of different
countries.

7
10.2 Growth in Rich Countries since 1950

8
10.2 Growth in Rich Countries since 1950

1. The standard of living has increased significantly since

1950.

2. There has been convergence, that is, the levels of output

per capita across the six countries have become closer over
time.

9
 10.2 Growth in Rich Countries since 1950

Countries with lower levels of output per person in 1950 have typically grown faster.

10
 10.3 A Broader Look across Time and Space

Across 106
countries
since 1960,
there is no
clear relation
between the
growth rate
of output
since 1960
and the level
of output per 11
person in
10.3 A Broader Look across Time and Space

• For the O E C D countries, there is clear evidence of

convergence.
• Convergence is also visible for many Asian
countries, especially for those with high growth
rates, called the four tigers—Singapore, Taiwan,
Hong Kong, and South Korea.
• Most African countries were very poor in 1960,
and some of them had negative growth of output
per person between 1960 and 2017 due in part to
internal or external conflicts. 12
10.4 Thinking About Growth: A Primer

• Aggregate production function F:

𝑌 = 𝐹 ( 𝐾 , 𝑁 ) ( 10.1)

where Y is output, K is capital, and N is

labour.
• The function F also depends on the state
of technology.

13
10.4 Thinking About Growth: A Primer

• The aggregate production function depends on the state of

technology. The higher the state of technology, the higher
output for a given K and a given N.

Y F ( K , AN )
 Later we will model better technology as making labour more effective
– i.e. an increase in A leads to a higher Y for a given K and a given N.

 For now, set A=1.

14
10.4 Thinking About Growth: A Primer

ASSUMED PROPERTIES:
1. Constant returns to scale: Increases in both factors by
proportion x increases output by x

𝑥𝑌 = 𝐹 ( 𝑥𝐾 , 𝑥𝑁 ) (10.2 )

2. Decreasing returns to capital: Increases in capital

only lead to smaller and smaller increases in output.
3. Decreasing returns to labour: Increases in labour
only lead to smaller and smaller increases in output.

15
10.4 Thinking About Growth: A Primer
• The production function and constant returns to scale imply a simple
relation between output per worker (Y/N) and capital per worker (K/N):
Setting x=1/N in (10.2) gives

𝑌
𝑁
=𝐹 ( 𝐾 𝑁
,
𝑁 𝑁
=𝐹 ) ( 𝐾
𝑁 )
,1 (10.3)
• Increases in capital per worker: Movements along the production function.
• Improvements in the state of technology: Shifts (up) of the production
function.
• Growth in Y/N comes from capital accumulation (via the saving rate)
and technological progress (the improvement in the state of
technology).

16
10.4 Thinking About Growth: A Primer
Decreasing returns to capital: Increases in capital per worker lead to
smaller and smaller increases in output per worker.

17
10.4 Thinking About Growth: A Primer
An improvement in technology shifts the production function up, leading
to an increase in output per worker for a given level of capital per worker.

18
Chapter 11
Saving, Capital
Accumulation and Output

2025 19
 Chapter 10 Outline
Saving, Capital Accumulation, and Output
11.1 Interactions between Output and Capital
11.2 The Implications of Alternative Saving Rates
11.3 Getting a Sense of Magnitudes
11.4 Physical versus Human Capital
APPENDIX The Cobb-Douglas Production Function and the
Steady State

20
11.1 Interactions between Output and Capital (1 of 5)

• Output in the long run depends on two relations:

1. The amount of capital determines the amount
of output being produced

2. The amount of output produced determines the

amount of saving, which in turn determines the
amount of capital being accumulated over time

21
11.1 Interactions between Output and Capital (2 of 5)

22
11.1 Interactions between Output and Capital (3 of 5)

• Recall Chapter 10:

𝑌
𝑁
=𝐹 ( )
𝐾
𝑁
,1 or 𝑓( ) ( )
𝐾
𝑁
=𝐹
𝐾
𝑁
,1

• Assume that N is constant, and there is no

technological progress, so f does not change over
time: 𝑌𝑡
𝑁
=𝑓 ( 𝐾𝑡
𝑁 )(11.1)
• Higher capital per worker leads to higher output
per worker.

23
11.1 Interactions between Output and Capital (4 of 5)

Assume:
• The economy is closed: I = S + (T − G)
• Public saving (T − G) is 0: I = S
• Private saving is proportional to income: S = sY
So, the relation between output and investment:
𝐼 𝑡 =𝑠 𝑌 𝑡
• Investment is proportional to output.
• The higher (lower) output is, the higher (lower) is
saving and so the higher (lower) is investment.
24
11.1 Interactions between Output and Capital (5 of 5)

• The evolution of the capital stock is:

𝐾 𝑡 +1=(1− 𝛿) 𝐾 𝑡 +𝐼 𝑡

• Replace investment by the above expression and

divide both sides by N:
𝐾 𝑡 +1 𝐾𝑡 𝑌𝑡
=(1 − 𝛿) +𝑠
𝑁 𝑁 𝑁

or 𝐾 𝑡 +1 𝐾𝑡 𝑌𝑡 𝐾𝑡
− =𝑠 −𝛿 (11.2)
𝑁 𝑁 𝑁 𝑁
• The change in the capital stock per worker is equal
to saving per worker minus depreciation.
25
11.2 The Implications of Alternative Saving Rates (1 of
10)

• Combining equations (11.1) and (11.2):

𝐾 𝑡 +1
𝑁
−
𝐾𝑡
𝑁
=𝑠𝑓 ( )
𝐾𝑡
𝑁
−𝛿
𝐾𝑡
𝑁
(11.3)

change in capital = Invesment − depreciation

• If investment per worker exceeds (is less than)
depreciation per worker, the change in capital per
worker is positive (negative).

26
11.2 The Implications of Alternative Saving Rates (2 of
10)
When capital and
output are low,
investment
exceeds
depreciation and
capital increases.
When capital and
output are high,
investment is less
than depreciation
and capital
decreases.
27
11.2 The Implications of Alternative Saving Rates (3 of
10)

• The state in which output per worker and capital

per worker are no longer changing is called the
steady state of the economy.
s 𝑓 ( 𝐾∗
𝑁 )
=𝛿
𝐾∗
𝑁
(11.4)

• The steady-state value of capital per worker is

such that the amount of saving per worker is
sufficient to cover depreciation of the capital stock
per worker.
( 𝑌∗
𝑁
=𝑓 ) ( 𝐾∗
𝑁 )
(11.5)

28
11.2 The Implications of Alternative Saving Rates (4 of
10)

• The saving rate has no effect on the long-run

growth rate of output per worker, which is equal to
zero.
• The saving rate determines the level of output per
worker in the long run.
• An increase in the saving rate will lead to higher
growth of output per worker for some time, but
not forever.

29
11.2 The Implications of Alternative Saving Rates (5 of
10)
A country
with a
higher
saving rate
achieves a
higher
steady-
state level
of output
per worker.

30
11.2 The Implications of Alternative Saving Rates (6 of
10)

An increase
in the saving
rate leads to
a period of
higher
growth until
output
reaches its
new higher
steady-state
level.
31
11.2 The Implications of Alternative Saving Rates (7 of
10)

An increase
in the saving
rate leads to
a period of
higher growth
until output
reaches its
new higher
steady-state
level.

32
11.2 The Implications of Alternative Saving Rates (8 of
10)

• What matters to people is not how many is produced,

but how much they consume.
• Governments can affect the saving rate by:
• changing public saving (budget surplus)
• using taxes to affect private saving
• Golden-rule level of capital: The level of capital
associated with the saving rate that yields the highest
level of consumption in steady state.

33
11.2 The Implications of Alternative Saving Rates (9 of
10)

An increase in
the saving rate
leads to an
increase, then
to a decrease in
steady-state
consumption
per worker.

34
11.2 The Implications of Alternative Saving Rates (10 of
10)

• For a saving rate between zero and the golden-

rule level, a higher saving rate leads to higher
capital per worker, higher output per worker and
higher consumption per worker.
• For a saving rate greater than the golden-rule
level, a higher saving rate still leads to higher
capital per worker and output per worker, but
lower consumption per worker.
• An increase in the saving rate leads to lower
consumption for some time but higher 35
consumption later.
11.3 Getting a Sense of Magnitudes (1 of
5)
• Assume the production function f:
𝑌 = √ K √ N (11.6 )
• so that equation (11.3) becomes:

𝐾 𝑡+1 𝐾 𝑡
• which𝑁
− =𝑠
√
𝐾𝑡
𝑁 the evolution
describes 𝑁 of 𝑁
𝐾𝑡
− 𝛿 (11.7)
capital over time.

36
11.3 Getting a Sense of Magnitudes (2 of
5)
• Equation (11.7) implies that capital per worker in
the steady state (K*/N) becomes:

( )
2
𝐾∗ 𝑠
= (11.8 )
𝑁 𝛿

• Combining equations (11.6) and (11.8) gives the

steady state output per worker:

√ ( )
2
𝑌∗ 𝐾∗ 𝑠 𝑠
= = = (11.9)
𝑁 𝑁 𝛿 𝛿
• In the long run, output per worker doubles when
the saving rate doubles.

37
11.3 Getting a Sense of Magnitudes (3 of
5)

38
11.3 Getting a Sense of Magnitudes (4 of
5)
• In the steady state, consumption per worker is:
𝐶 𝑌 𝐾
= −𝛿
𝑁 𝑁 𝑁

• Given equations (11.8) and (11.9), the steady-

state consumption per worker is:
𝐶 𝑠
= −𝛿
𝑁 𝛿 𝛿 ()
𝑠 2 𝑠(1− 𝑠)
=
𝛿

• Table 11.1 gives the steady-state values of capital

per worker, output per worker and consumption
per worker for different saving rates (given
δ=10%) 39
11.3 Getting a Sense of Magnitudes (5 of
5)

40
11.4 Physical versus Human Capital (1 of
2)
• Human capital (H): The set of skills of the
workers in the economy built through education
and on-the-job training.
• The production function with human capital:
𝑌
𝑁
=𝑓
𝐾 𝐻
,
𝑁 𝑁((11.10 ) )
• As for physical capital (K) accumulation, countries
that save more or spend more on education can
achieve higher steady-state levels of output per
worker.
41
11.4 Physical versus Human Capital (2 of
2)

• Models of endogenous growth: Steady-state

growth in output per worker depends on variables
such as the saving rate and the rate of spending
on education, even without technological
progress.
• However, the current consensus is that given the
rate of technological progress, higher rates of
saving or spending on education do not lead to a
permanently higher growth rate.

42