MacroeconomicsI_working_version (1)

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Chapter 4
4.2.1. Growth Accounting: The Production Function
Growth of output results from rises in inputs (factors of production) and from rises in
productivity due to improved technology and more available labour force. The production
function provides a quantitative link between inputs and outputs. To make a simplification,
let’s first assume that labour (L) and capital (K) are the only important inputs. Equation (1)
shows that output (Y) is determined by inputs and technology (A).
Y = AF (K,N) (1)
The production function in equation (1) could be transformed into a very specific prediction
relating input growth and output growth. The growth accounting equation summarises this
prediction:
ΔY/Y =[(1 - Ө) * ΔN / N] + (Ө * ΔK / K) + ΔA /A (2)
Equation (2) summarizes how rise in input and improved productivity contribute to the
growth of output:
• An amount by which labour and capital each contribute to growth of output equal to their
individual growth rates multiplied by the share of that input in income.
• The third term in equation (2) is technical progress presented by the rate of improvement
of technology (also called the growth of total factor productivity).
The growth rate of total factor productivity is the amount by which output would increase as a
result of improvements in methods of production, with all inputs unchanged.
4.2.2. Growth Theories: Neo-classical Growth Theory (R. Solow)
The model: The origins of Neo-classical Growth Theory come from the late 1950’s and the
1960’s. Robert Solow is the best-known contributor to this growth theory. The theory
concentrates on accumulation of capital and its link to savings decisions and the like.
Neoclassical growth theory begins with a simplifying assumption: there is no technological
progress in the economy. This implies that the economy reaches a long-run level of output
and capital called the steady-state equilibrium. The steady-state equilibrium for the economy
is the combination of per capita GDP and per capita capital where the economy will remain at
rest, that is where per capita economic variables are no longer changing, Δy = 0 and Δk = 0.
The growth theory mostly deals with studying the transition from the economy’s current
position to this steady state. The technological progress is added to the model, as a final step.