Sources of Economic Growth

Macroeconomic Theory I

ECON222

Fall 2017

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Main questions

What are the sources of economic growth?

What forces determine long-run living standards?

What are government policies to inuence the rate of growth?

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Sources of economic growth

The relationship between output and inputs is described by the

production function:
Y = AF (K , N )

For Y to grow, either K or N must grow or productivity, A, must

improve, or both.

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The growth accounting equation

The growth accounting equation:

Y A K N
= + K + N
Y A K N
where
K = elasticity of output with respect to capital (' 0.3)
N = elasticity of output with respect to labour (' 0.7)

The elasticity of output with respect to an input is the % increase in

output resulting from a one % increase in the input

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Growth accounting

Measures empirically the relative importance of capital stock, labour

and productivity for economic growth

Growth of K and N are estimated from historical data

Growth in total factor productivity is treated as a residual:

A Y K N
= K N
A Y K N
,! a measure of our ignorance

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Example: Canada

Between 1987 and 2012:

N
= 0.014
N
K
= 0.023
K
Y
= 0.027
Y
Elasticities are N = 0.7 and K = 0.3

What were the contributions of labour and capital to overall growth?

What was TFP growth?

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Growth accounting and the productivity slowdown

Rapid output growth during 1962-1973 has slowed in 1974-2016

Much of the decline in output growth is accounted for by a decline in

productivity growth

The slowdown in productivity since 1974 is widespread

,! observed in the US, Western Europe and Japan

The reasons for this are unclear

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