Chapter 11

Saving, Capital
Accumulation, and Output
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39
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Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard
Saving, Capital Accumulation,
and Output
The effects of the saving rate - the ratio of
saving to GDP on capital and output per
capita are the topics of this chapter.

An increase in the saving rate would lead to
higher growth for some time, and eventually
to a higher standard of living in the United
States.
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Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard
11-1 Interactions between Output
and Capital
At the center of the determination of output
in the long run are two relations between
output and capital:

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

The amount of output determines the
amount of saving and, in turn, the amount
of capital accumulated over time.
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Capital, Output, and
Saving/Investment
Figure 11 - 1
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Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard
11-1 Interactions between Output
and Capital
Under constant returns to scale, we can write the
relation between output and capital per worker as
follows:
5 of 39
, 1
Y K
F
N N
| |
=
|
\ .
The Effects of Capital on Output
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Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard
Since the focus here is on the role of capital
accumulation, we make the following assumptions:

The size of the population, the participation rate,
and the unemployment rate are all constant.

There is no technological progress.
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The Effects of Capital on Output
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With these two assumptions, our first relation
between output and capital per worker, from the
production side, can be written as
7 of 39
Y
N
f
K
N
t t
=
|
\

|
.
|
In words, higher capital per worker leads to higher
output per worker.
The Effects of Capital on Output
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Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard
To derive the second relation, between output
and capital accumulation, we proceed in two
steps:

1. We derive the relation between output and
investment.

2. We derive the relation between investment
and capital accumulation.
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The Effects of Output on Capital Accumulation
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Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard
We make three assumptions to derive the
relation between output and investment:

We assume the economy is closed.

We assume public saving, T G, is equal to
zero.

We assume that private saving is proportional
to income, so

Combining these two relations gives:
I S =
9 of 39
I S T G = + ( )
I sY
t t
=
S sY =
The Effects of Output on Capital Accumulation
Output and Investment
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Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard
The evolution of the capital stock is given by:
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o denotes the rate of depreciation
I sY
t t
=
Combining the relation from output to investment,
, and the relation from investment to capital
accumulation, we obtain the second important relation
we want to express, from output to capital accumulation:
K K I
t t t +
= +
1
1 ( ) o
K
N
K
N
s
Y
N
t t t +
= +
1
1 ( ) o
The Effects of Output on Capital Accumulation
Investment and Capital Accumulation
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Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard
Rearranging terms in the equation above, we can
articulate the change in capital per worker over time:
11 of 39
The Effects of Output on Capital Accumulation
Investment and Capital Accumulation
In words, the change in the capital stock per worker (left side)
is equal to saving per worker minus depreciation (right side).
K
N
K
N
s
Y
N
t t t +
= +
1
1 ( ) o
K
N
K
N
s
Y
N
K
N
t t t t +
=
1
o
Output and Capital per Worker:
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Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard
Our two main relations
are:
12 of 39
Combining the two relations, we can study the behavior
of output and capital over time.
First relation:
Capital determines
output.
Y
N
f
K
N
t t
=
|
\

|
.
|
K
N
K
N
s
Y
N
K
N
t t t t +
=
1
o
Second relation:
Output determines
capital accumulation
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N
K
N
K
t t

+1
Change in capital
from year t to year t + 1
N
K
t
o
_
Depreciation
during year t
_
|
.
|

\
|
N
K
sf
t
=
Investment
during year t
=
Dynamics of Capital and Output
From our main relations above, we express output per
worker (Y
t
/N) in terms of capital per worker to derive the
equation below:
Y
N
f
K
N
t t
=
|
\

|
.
|
K
N
K
N
s
Y
N
K
N
t t t t +
=
1
o
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This relation describes what happens to capital per worker. The
change in capital per worker from this year to next year depends on
the difference between two terms:

If investment per worker exceeds depreciation per worker, the
change in capital per worker is positive: Capital per worker
increases.

If investment per worker is less than depreciation per worker,
the change in capital per worker is negative: Capital per
worker decreases.
Dynamics of Capital and Output
N
K
N
K
t t

+1
Change in capital
from year t to year t + 1
N
K
t
o
_
Depreciation
during year t
_
|
.
|

\
|
N
K
sf
t
=
Investment
during year t
=
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15 of 39
Dynamics of Capital and Output
At K
0/N
, capital per
worker is low,
investment exceeds
depreciation, thus,
capital per worker
and output per
worker tend to
increase over time.
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Dynamics of Capital and Output
At K*/N, output per
worker and capital
per worker remain
constant at their
long-run equilibrium
levels.
Investment per worker increases with capital per worker, but by less
and less as capital per worker increases.
Depreciation per worker increases in proportion to capital per worker.
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Dynamics of Capital and Output
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.
Capital and Output
Dynamics
Figure 11 - 2
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Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard
The state in which output per worker and capital per worker are
no longer changing is called the steady state of the economy. In
steady state, the left side of the equation above equals zero, then:
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* * K K
sf
N N
o
| |
=
|
\ .
* * Y K
f
N N
| |
=
|
\ .
Given the steady state of capital per worker (K*/N), the steady-
state value of output per worker (Y*/N), is given by the
production function:
K
N
K
N
K
N
t t t +

|
\

|
.
|
1
= sf
K
N
t
o
Steady-State Capital and Output
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Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard
Three observations about the effects of the saving rate
on the growth rate of output per worker are:

1. The saving rate has no effect on the long run
growth rate of output per worker, which is equal to
zero.

2. Nonetheless, the saving rate determines the level
of output per worker in the long run. Other things
equal, countries with a higher saving rate will
achieve higher output per worker in the long run.

3. An increase in the saving rate will lead to higher
growth of output per worker for some time, but not
forever.
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The Saving Rate and Output
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The Saving Rate and Output
A country with a higher
saving rate achieves a
higher steady- state level
of output per worker.
The Effects of Different
Saving Rates
Figure 11 - 3
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The Saving Rate and Output
An increase in the saving rate
leads to a period of higher
growth until output reaches its
new, higher steady-state level.
The Effects of an
Increase in the Saving
Rate on Output per
Worker
Figure 11 - 4
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The Saving Rate and Output
An increase in the saving rate
leads to a period of higher
growth until output reaches a
new, higher path.
The Effects of an
Increase in the Saving
Rate on Output per
Worker in an Economy
with Technological
Progress
Figure 11 - 5
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23 of 39
The Saving Rate and Consumption
An increase in the saving rate always leads to an increase in the
level of output per worker. But output is not the same as
consumption. To see why, consider what happens for two
extreme values of the saving rate:
An economy in which the saving rate is (and has always
been) 0 is an economy in which capital is equal to zero. In
this case, output is also equal to zero, and so is
consumption. A saving rate equal to zero implies zero
consumption in the long run.
Now consider an economy in which the saving rate is equal
to one: People save all their income. The level of capital,
and thus output, in this economy will be very high. But
because people save all their income, consumption is equal
to zero. A saving rate equal to one also implies zero
consumption in the long run.
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The level of capital associated with
the value of the saving rate that yields
the highest level of consumption in
steady state is known as the golden-
rule level
of capital.
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The Saving Rate and Consumption
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The Saving Rate and Consumption
An increase in the saving rate
leads to an increase and then
to a decrease in steady-state
consumption per worker.
The Effects of the
Saving Rate on Steady-
State Consumption per
Worker
Figure 11 - 6
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26 of 39
Social Security, Saving, and Capital Accumulation
One way to run a social security system is the fully-
funded system, where workers are taxed, their
contributions invested in financial assets, and when
workers retire, they receive the principal plus the interest
payments on their investments.

Another way to run a social security system is the pay-
as-you-go system, where the taxes that workers pay
are the benefits that current retirees receive.

.
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Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard
Assume the production function is:
27 of 39
Y K N =
Y
N
K N
N
K
N
K
N
= = =
f
K
N
K
N
t t
|
\

|
.
| =
Output per worker is:
Output per worker, as it relates to capital per worker is:
Given our second relation,
K
N
K
N
K
N
t t t +

|
\

|
.
|
1
= sf
K
N
t
o
K
N
K
N
s
K
N
K
N
t t t t +
=
1
o
Then,
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Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard
Steady-state output per worker is equal to the
ratio of the saving rate to the depreciation rate.

A higher saving rate and a lower depreciation
rate both lead to higher steady-state capital per
worker and higher steady-state output per worker.
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2
* * Y K s s
N N o o
| |
= = =
|
\ .
The Effects of the Saving Rate on Steady-State Output
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29 of 39
The Dynamic Effects of an Increase in the Saving Rate
It takes a long time for output to
adjust to its new, higher level
after an increase in the saving
rate. Put another way, an
increase in the saving rate
leads to a long period of higher
growth.
The Dynamic Effects of
an Increase in the
Saving Rate from 10% to
20% on the Level and
the Growth Rate of
Output per Worker
Figure 11 - 7
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In steady state, consumption per worker is equal to
output per worker minus depreciation per worker.
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Knowing that:
C
N
Y
N
K
N
= o
( )
C
N
s s s s
=
|
\

|
.
| =

o
o
o o
2
1
then:
2
* * Y K s s
N N o o
| |
= = =
|
\ .
and
2
* K s
N o
| |
=
|
\ .
These equations are used to derive Table 11-1 in the next slide.
The Saving Rate and the Golden Rule
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Table 11-1 The Saving Rate and the Steady-state Levels of
Capital, Output, and Consumption per Worker
Saving Rate, s
Capital per
Worker, (K/N)
Output per
Worker, (Y/N)
Consumption per
Worker, (C/N)
0.0 0.0 0.0 0.0
0.1 1.0 1.0 0.9
0.2 4.0 2.0 1.6
0.3 9.0 3.0 2.1
0.4 16.0 4.0 2.4
0.5 25.0 5.0 2.5
0.6 36.0 6.0 2.4

1.0 100.0 10.0 0.0
The U.S. Saving Rate and the Golden Rule
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Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard
11-4 Physical versus Human
Capital
The set of skills of the workers in the economy is
called human capital.

An economy with many highly skilled workers is
likely to be much more productive than an
economy in which most workers cannot read or
write.

The conclusions drawn about physical capital
accumulation remain valid after the introduction
of human capital in the analysis.
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Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard
11-4 Physical versus Human
Capital
When the level of output per workers depends
on both the level of physical capital per worker,
K/N, and the level of human capital per worker,
H/N, the production function may be written as:
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Y
N
f
K
N
H
N
=
|
\

|
.
| ,
( , ) + +
An increase in capital per worker or the average skill
of workers leads to an increase in output per worker.
Extending the Production Function
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Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard
11-4 Physical versus Human
Capital
A measure of human capital may be
constructed as follows:

Suppose an economy has 100 workers, half of
them unskilled and half of them skilled. The
relative wage of skilled workers is twice that of
unskilled workers.

Then:
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H
H
N
= + = = = [( ) ( )] . 50 1 50 2 150
150
100
15
Extending the Production Function
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Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard
An increase in how much society saves in the
form of human capitalthrough education and
on-the-job-trainingincreases steady-state
human capital per worker, which leads to an
increase in output per worker.

In the long run, output per worker depends not
only on how much society saves but also how
much it spends on education.
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Human Capital, Physical Capital, and Output
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Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard
In the United States, spending on education comprises
about 6.5% of GDP, compared to 16% investment in
physical capital. This comparison:

Accounts for the fact that education is partly
consumption.

Does not account for the opportunity cost of
education.

Does not account for the opportunity cost of on-the-
job-training.

Considers gross, not net investment. Depreciation of
human capital is slower than that of physical capital.
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Human Capital, Physical Capital, and Output
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Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall Macroeconomics, 5/e Olivier Blanchard
A recent study has concluded that output per worker depends
roughly equally on the amount of physical capital and the amount
of human capital in the economy.

Models that generate steady growth even without technological
progress are called models of endogenous growth, where growth
depends on variables such as the saving rate and the rate of
spending on education.

Output per worker depends on the level of both physical capital
per worker and human capital per worker.

Is technological progress unrelated to the level of human capital
in the economy? Cant a better-educated labor force lead to
a higher rate of technological progress? These questions take us
to the topic of the next chapter: the sources and the effects of
technological progress.
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Endogenous Growth