The theories of economic growth

Adam Smith Inquiry into the Nature and Causes of the Wealth of Nations (1776):

Advocated division of labor, specialization (absolute advantage) & accumulation of capital

Advocated Laissez Faire - minimum government interference

Emphasized importance of a stable legal framework, within the market could function

 

David Ricardo:

Formalized notion of diminishing returns, but did not take innovation into account

Showed some of the welfare gains from specialization and international trade based on comparative advantage

 

Robert Solow: Neo-classical growth model

Growth depends on capital accumulation - increasing the stock of capital goods to expand productive capacity

Net investment and the need for sufficient saving to finance investment

Higher savings - postponing consumption to finance increased allocation of resources towards investment

Capital widening: capital stock rising at rate which keeps pace with labor force growth.

Capital deepening: capital stock grows faster than labor force. Considered more important.

Quality of capital goods - improvements due to R&D & innovation

Solow - a combination of capital deepening & technological improvement explains major trends in economic growth

1. Prediction - Adding more capital goods to a fixed amount of labor will lead to diminishing returns to capital.

2. Increased capital accumulation drives the rate of return on capital down

3. Eventually, the rate of return may be so low that no further net capital accumulation takes place.

4. In which case the rate of technological progress determined the rate of growth of output

Technological progress is assumed to be exogenous i.e. lies outside the growth model

Schumpeter:

Schumpeterian innovation - an explanation of technological progress

Long waves of innovation - "gales of creative destruction"

Increased profits arise because of constant birth of new products and new markets.

Technology raises productivity by increasing quantity and quality of all those resources to which it is applied.

 

 

Aggregate demand (AD). AD curve.

Aggregate demand (AD) is the total demand for goods and services produced in the economy over a period of time.

- the total amounts of nation’s output that buyers collectively desire to purchase at each possible price level. (уровень цен <- обратный)

- There is an inverse relationship b

- between a nation’s price level and the amount of output demanded

 

P^r

 

 

AD

Y

P - price level

                                          Y - real output or income

18. Determinants of AD.

 The determinants work through the four aggregate expenditure categories--consumption expenditures, investment expenditures, government purchases, and net exports. Should any specific aggregate demand determinant change, it must affect the aggregate demand curve through one of the four aggregate expenditures.

 

Aggregate supply (AS); Determinants of AS.

Aggregate Supply (AS) - the total amount of goods and services that all industries in the economy will produce at every given price level.

The assortment of aggregate supply determinants fall into three categories (1) resource quantity--the amounts of labor, capital, land, and entrepreneurship available, (2) resource quality--the productivity of the four factors of production, and (3) resource price--the prices of the inputs used in production.

Segments of AS curve.

AS curve consists of 3 segments:

1) horizontal (O-Y1)  

2) Intermediate (up sloping) Y1- Y2

3) Vertical Y2

 

HORIZONTAL SEGMENT

-Real levels of output are less than the full - employment output

-The economy is in a recession

-the large amounts of unused machinery and unemployed workers are available for production

-workers unemployed for a few months will hardly expect a wage increase

-the price is on the same level

 

INTERMEDIATE SEGMENTS OF AS

Real out put rises!

-an expansion of real output is accompanied by a rising price level

per-unit production costs rise and firms must receive higher product prices for their output to be profitable

 

 VERTICAL SEGMENT

-the economy reaches full capacity real OR FULL EMPLOYMENT real output-Individual firms may try to expand production by bidding resources away from other firms Thus bidding will raise resources price (costs) and product prices-

-BUT real output will remain UNCHANGED (is stable)

AS: the Keynesian vs. Classical Debate.

The Classical theory:          The fundamental principle of the classical theory is that the economy is self-regulating. Classical economists maintain that the economy is always capable of achieving the natural level of real GDP or output, which is the level of real GDP that is obtained when the economy's resources are fully employed. The classical doctrine—that the economy is always at or near the natural level of real GDP—is based on two firmly held beliefs: Say's Law and the belief that prices, wages, and interest rates are flexible.

The Keynesian theory:        Keynes's theory of the determination of equilibrium real GDP, employment, and prices focuses on the relationship between aggregate income and expenditure. Keynes used his income-expenditure model to argue that the economy's equilibrium level of output or real GDP may not correspond to the natural level of real GDP. In the income-expenditure model, the equilibrium level of real GDP is the level of real GDP that is consistent with the current level of aggregate expenditure. If the current level of aggregate expenditure is not sufficient to purchase all of the real GDP supplied, output will be cut back until the level of real GDP is equal to the level of aggregate expenditure. Hence, if the current level of aggregate expenditure is not sufficient to purchase the natural level of real GDP, then the equilibrium level of real GDP will lie somewhere below the natural level.