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Investment in New Capital

Investment in New Capital. DOUBLE FEATURE. DOUBLE FEATURE. Technology and Economic Growth. The story of economic growth goes on. General framework: Y = F( L , K ,T) Previous lecture looked at L and began an analysis of K

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Investment in New Capital

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  1. Investment in New Capital DOUBLE FEATURE DOUBLE FEATURE Technology and Economic Growth

  2. The story of economic growth goes on • General framework: Y = F(L,K,T) • Previous lecture looked at Land began an analysis of K • Today we continue our discussion of capital (K) by using the model--developed last time--of the shares of spending in the whole economy • We then go on to consider technology T

  3. Spending Allocation Model(C/Y) + (I/Y) + (X/Y) + (G/Y) = 1 • In words, sum of spending shares equals 1 • Or: (C/Y) + (I/Y) + (X/Y) = 1 - (G/Y) • LEFT HAND SIDE depends negatively on the interest rate. (Because each of C/Y, I/Y, and X/Y depends on interest rate) • Find interest rate that satisfies the equation • Then find (C/Y), (I/Y), (X/Y)

  4. Recall this graph from previous lecture

  5. Can you draw this by hand as in an examination? • Yes, • Show all four graphs. • Focus on the (d) graph

  6. Now consider the effects of an increase in G/Y • That is, government purchases rise as a share of GDP (like 1980s Reagan defense buildup) • “Permanent” or at least long lasting • Look at long-run effects • About 5 years, but we are not really sure how long the long run is

  7. First use the rough sketch

  8. Now look at the graphs drawn to scale to see what happens if G/Y increases by a particular amount ?

  9. Summary of effects of an increase in G/Y • higher interest rate • higher dollar exchange rate • (example: 160 yen per dollar rather than 120 yen per dollar) • investment lower (I/Y down) • lower net exports (X/Y down) • trade deficit rises

  10. Key points about SAM • Applies to the long-run • The short run effects could be different • The interest rate is the real interest rate • real interest rate = interest rate minus expected rate of inflation • Can also look at other issues: • (G/Y) down, or shifts in (I/Y), (C/Y), or (X/Y) • good exam question!

  11. Saving-investment approach • Exploits idea that by definition national saving S = Y - C - G • or (S/Y) = 1 - (C/Y) - (G/Y) • thus S/Y is positively related to the interest rate • Also (I/Y) + (X/Y) is negatively related to the interest rate • Finally S = I + X • or S/Y = I/Y + X/Y

  12. The effects of an increase in government purchases (G/Y)

  13. Labor Alone: diminishing returns, subsistence, Malthusian equilibrium

  14. The Malthusian dynamics

  15. Labor and Capital Alone

  16. Adding capital avoids Malthusian equilibrium

  17. But capital also has diminishing returns, so growth would not continue with capital and labor alone; need something else:technology

  18. Some other evidence that technology is essential

  19. End of Lecture

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