Introduction of Endogenous Growth Model

1. Introduction of Endogenous Growth Model Presented by: ABDUL RAHIM RIDZUAN GS19006 MOHD AZLAN ABDUL MAJID GS19054 FAZRUL AZLAN OTHMAN GS20629 BAWANI A/P TAMBY DURAI GS18796

2. Objective To explain about the Endogenous growth model To briefly describe the economic policy and growth

3. Endogenous Growth Model The primary deficiency of Solow Growth Model is that it does not explain the key observation which is growth itself. Therefore we need Endogenous Growth Model develop by Robert Lucas In this model the representative consumer allocates time between Supply labor to produce output and accumulating human capital.

4. Human Capital Accumulation

5. Endogenous Model and Human Capital Accumulation Key features of human capital is nonrivalrous. Given person’s acquisition of knowledge does not reduce the ability of someone else to acquire the same knowledge. It does not have diminishing of return. The lack of diminishing returns to human capital investment leads to unbounded growth (constant growth) in the model. Example : When we invest in human capital accumulation, the income and growth will constant with what we invest before.

6. The Representative Consumer In each period, consumer has unit of time which can be allocated between work and accumulating human capital. Assume the consumer does not use time for leisure and cannot save. C=wuHs C = consumption w= wages u= fraction of time devoted to working Hs = current stocks of human capital uHs= efficiency of labor supply

7. The Representative Consumer The accumulation of human capital Hs’= stock of human capital in the future b, b>0 = parameter that captures the efficiency of human capital accumulation technology Example: Expand on firm R&D, government education expenditure (1-u) =fraction time devoted to learning Hs =stock of current human capital (1-u)Hs= number of current efficiency units of labor devoted to human capital accumulation

8. The Representative Firm For simplicity, no physical capital in this model Production function : Y = current output Z = marginal product efficiency units of labor (technologies) uHd = current input efficiency units of labor Example: 1% uHd 1% output (constant return to scale)

9. The Representative Firm Firm problem: If z-w < 0 profits are negative if the firm hires a positive quantity of efficiency units of labor If z-w > 0, then profits are (z-w) for each efficiency unit hired If z=w, firm profit same of any quantity worker hired firm is indifferent about quantity of efficiency units of labor hired conclusion: The firm’s demand curve for efficiency unit if labor is infinitely elastic at z=w

10. Competitive Equilibrium The figure shows demand and supply of efficiency unit of labor in the endogenous growth model. The constant z, is the marginal product of efficiency units of labor. Only one market on which consumption goods are traded for efficiency units of labor Firm demand curve for efficiency units of labor is infinitely elastic at w=z This implies that no matter what the supply curve for efficiency units of labor, the intersection between demand & supply always occurs. This market always clears at a real wage of w=z. market clearing gives uHs=uHd (The supply of efficiency units of labor is equal to demand)

11. Competitive equilibrium So Labor market clears We have C= zuH H′= b(1-u)H

12. Competitive Equilibrium • The figure shows the relationship between the future human capital (H’) and the current human capital (H) (H’ as a function of H) • The slope of colored line is b(1-u) • If b(1-u) > 1, then H’ > H • So that future human capital is always greater than current human capital. So human capital increases forever. • Therefore, human capital grows over time without bound.

13. The growth rate of human capital is: The growth rate is a constant Important points: Growth rate of human capital if b or if u b determines the efficiency of the human capital accumulation technology. It can be interpreted as the efficiency of educational sector. Thus, the model predicts that countries with more efficient education systems should experience higher rates of growth in human capital. If u decreases, then more time is devoted to human capital accumulation and less to producing output in each period. And this causes the growth rate in human capital to increase. Growth Rate

14. Growth rate C′ = zuH′ • We have consumption in the future • The growth rate of consumption would be: • The growth rate of consumption is identical to growth rate of human capital. C=Y • Therefore, human capital ,consumption & output all grow at the same rate • [ b(1-u)-1], in equilibrium. C’/C – 1 = zuH’/zuH – 1 = H’/H – 1 = b(1-u) -1

15. This model economy does not grow because of any exogenous forces. • There is no population growth, and no change in production technology • Therefore, growth occurs because of endogenous forces, with the growth rate determined by b and u • Thekey element: the production function has constant return to scale in human capital • If the human capital increases by 10%, then, holding u constant, output increases by 10%. • Because knowledge is nonrivalrous; additional education and skills do not reduce the extra output that can be achieved through the acquisition of more education and skills

16. Summary We constructed an endogenous growth model with human capital accumulation. This model has the property that, even with no increase in total factor productivity and no population growth, there can be unlimited growth in the stock of human capital (skill and education) In the endogenous growth model, the rate of growth of output and consumption is determined by the efficiency of human capital accumulation and the allocation of labor time between goods production and human capital accumulation. If the government could introduce policies that altered the efficiency of human capital accumulation or the allocation of labor time, it could alter the rate of economic growth in the endogenous growth model.