Economic models
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Transcript of Economic models
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Economic models
…are simplied versions of a more complex reality• irrelevant details are stripped away
Used to • show the relationships between economic variables
• explain the economy’s behavior
• devise policies to improve economic performance
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A World of Rich and Poor
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A Country of Rich and Poor
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A Country of Rich and Poor
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Are Poor Countries Catching Up?
☻ ☻ ☻
0 2,000
1.0
3.0
Per capita income in 1870 (1975 dollars)
Gro
wth
rat
e (%
)
Growth Rates vs. Per Capita Income for Currently Developed Countries, 1870-1979
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Source: Barrow and Sala-i-Martin (1995).
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GDP per Cap Relative to the U.S., 1960 vs. 1988 (log scale)
Income Relative to U.S., 1960
Inco
me
Rel
ativ
e to
U.S
., 19
88
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Convergence
• Solow model predicts that, other things equal, “poor” countries (with lower Y/L and K/L ) should grow faster than “rich” ones.
• If true, then the income gap between rich & poor countries would shrink over time, and living standards “converge.”
• In real world, many poor countries do NOT grow faster than rich ones. Does this mean the Solow model fails?
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Convergence
• No, because “other things” aren’t equal. In samples of countries with similar savings
& pop. growth rates, income gaps shrink about 2%/year.
In larger samples, if one controls for differences in saving, population growth, and human capital, incomes converge by about 2%/year.
• What the Solow model really predicts is conditional convergence - countries converge to their own steady states, which are determined by saving, population growth, and education. And this prediction comes true in the real world.
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Prediction:Prediction:
Higher s higher k*.
And since y = f(k) , higher k* higher y* .
Thus, the Solow model predicts that countries with higher rates of saving and investment will have higher levels of capital and income per worker in the long run.
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Egypt
Chad
Pakistan
Indonesia
ZimbabweKenya
India
CameroonUganda
Mexico
IvoryCoast
Brazil
Peru
U.K.
U.S.Canada
FranceIsrael
GermanyDenmark
ItalySingapore
Japan
Finland
100,000
10,000
1,000
100
Income per person in 1992(logarithmic scale)
0 5 10 15Investment as percentage of output (average 1960–1992)
20 25 30 35 40
International Evidence on Investment Rates and Income per Person
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Prediction:Prediction:
Higher n lower k*.
And since y = f(k) , lower k* lower y* .
Thus, the Solow model predicts that countries with higher population growth rates will have lower levels of capital and income per worker in the long run.
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Chad
Kenya
Zimbabwe
Cameroon
Pakistan
Uganda
India
Indonesia
IsraelMexico
Brazil
Peru
Egypt
Singapore
U.S.
U.K.
Canada
FranceFinlandJapan
Denmark
IvoryCoast
Germany
Italy
100,000
10,000
1,000
1001 2 3 40
Income per person in 1992(logarithmic scale)
Population growth (percent per year) (average 1960 –1992)
International Evidence on Population International Evidence on Population Growth and Income per PersonGrowth and Income per Person
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In the Solow model of Chapter 7, the production technology is held constant income per capita is constant in the steady
state.
Neither point is true in the real world: 1929-2001: U.S. real GDP per person grew by
a factor of 4.8, or 2.2% per year. examples of technological progress abound
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Examples of technological progress
• 1970: 50,000 computers in the world2000: 51% of U.S. households have 1 or more computers
• The real price of computer power has fallen an average of 30% per year over the past three decades.
• The average car built in 1996 contained more computer processing power than the first lunar landing craft in 1969.
• Modems are 22 times faster today than two decades ago.
• Since 1980, semiconductor usage per unit of GDP has increased by a factor of 3500.
• 1981: 213 computers connected to the Internet2000: 60 million computers connected to the Internet
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“Living Standards” in the U.S.
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What About Happiness?Subjective well-being rankings of 82 societies
(based on combined Happiness and Life Satisfaction scores) HIGH MEDIUM HIGH MEDIUM-LOW LOW Puerto Rico 4.67 Mexico 4.32 Denmark 4.24 Ireland 4.16 Iceland 4.15 Switzerland 4.00 N. Ireland 3.97 Colombia 3.94 Netherlands 3.86 Canada 3.76 Austria 3.69 El Salvador 3.67 Venezuela 3.58 Luxembourg 3.52 U.S. 3.47 Australia 3.46 New Zealand 3.39 Sweden 3.36 Nigeria 3.32 Norway 3.25 Belgium 3.23 Finland 3.23
Saudi Arabia 3.01 Singapore 3.00 Britain 2.92 W. Germany 2.67 France 2.61 Argentina 2.61 Vietnam 2.59 Chile 2.53 Philippines 2.32 Taiwan 2.25 Domin.Rep. 2.25 Brazil 2.23 Spain 2.13 Israel 2.08 Italy 2.06 E. Germany 2.02 Slovenia 2.02 Uruguay 2.02 Portugal 1.99 Japan 1.96 Czech Rep 1.94
S. Africa 1.86 Croatia 1.55 Greece 1.45 Peru 1.32 China 1.20 S. Korea 1.12 Iran 0.93 Poland 0.84 Turkey 0.84 Bosnia 0.82 Morocco .74 Uganda 0.67 Algeria 0.57 Bangladesh 0.54 Egypt 0.52 Hungary 0.41 Slovakia 0.40 Jordan 0.39
Estonia 0.24 Serbia 0.21 Tanzania 0.13 Azerbaijan 0.13 Montenegro 0.06 India 0.03 Lithuania -0.07 Macedonia -0.14 Pakistan -0.30 Latvia -0.70 Albania -0.86 Bulgaria -0.87 Belarus -0.92 Georgia -1.11 Romania -1.30 Moldova -1.63 Russia -1.75 Armenia -1.80 Ukraine -1.81 Zimbabwe -1.88 Indonesia -2.40
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Can You “Buy” Happiness?
Income vs Happiness
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0 10,000 20,000 30,000 40,000 50,000 60,000
GDP per capita
We
ll-B
ein
g S
core