ECO302: Intermediate Macroeconomic Theory I: Spring 2021

ECO302:
Spring 2021
Intermediate Macroeconomic Theory I
Lecture-3: Long-Run Economic Growth

Charles I. Jones Chapter3
Instructor: Biplob Nandi

East West University
CHAPTER ORGANIZATION
What is long-run economic growth and its
measurements?
How economic growth has dramatically improved
welfare?
Some tools used to study economic growth, including
how to calculate growth rates
 Growth accounting and the sources of long-run
economic growth
UNDERSTANDING THE LONG-RUN ECONOMIC GROWTH
 Long-run growth is defined as the sustained rise in

the quantity of goods and services that an economy
produces.
 A economy has a steady long-run economic
performance when the GDP of a country is closely
tied to the growth of the population in addition to
prices and supply and demand.
 Measuring the long-run economic growth explains
that how much standard of living increases of an
economy
MEASUREMENT OF LONG-RUN ECONOMIC GROWTH
 Measuring the standard of living and welfare of an economy,
the following dimension can be considered as crucial
Indicators:
1. Per capita real GDP
2. Literacy rate or mean years of schooling
3. Life expectancy rate
Real GDP per capita = (Gross real GDP/population), therefore,
keeping the population at lower level, total factor productivity
is key to maintain the upward trend of standard of living.
KEY FACTS: LONG-RUN ECONOMIC GROWTH
Source: WDI, World Bank

GROWTH OVER THE VERY LONG RUN
 Understanding the long-run economic growth, we have to

consider the two crucial points:
1. How much an economy has grown over time?
2. How large the gaps are between wealthy countries and
countries that have yet to match our growth record(LDCs and
developing countries)
Thus, per capita GDP differs remarkably around the globe
 The question-1 and question-2 explains the growth
divergence or convergence phenomenon in the theory of long-
run economic growth.
GROWTH OVER THE VERY LONG RUN
BANGLADESH: REAL GDP GROWTH RATE
Real GDP Per Capita(2010 Constant US$)
9000
8000
7000
6000
5000
4000
3000
2000
1000
BGD CHN IND Rwanda
Source: WDI Data, World Bank

Real GDP Growth between Bangladesh and China)
30.0
20.0
10.0
0.0
-10.0
-20.0
-30.0
BGD CHN
Real GDP Growth: Bangladesh and India
15.0
10.0
5.0
0.0
-5.0
-10.0
-15.0
-20.0
BGD IND
Real GDP Growth: Bangaldesh and Rawanda
40.0
30.0
20.0
10.0
0.0
-10.0
-20.0
-30.0
-40.0
-50.0
-60.0
BGD Rwanda
LONG RUN GROWTH: THE GREAT DIVERGENCE
 The recent era of increased difference in standards

of living across countries.
 Before 1700
• Per capita GPD in nations differed only by a factor of
two or three.
 Today
• Per capita GPD differs by a factor of 50 for several
countries.
MODERN ECONOMIC GROWTH
Timeline: from 1870 to 2000, United States per
capita GDP
. . . . . rose by nearly 15-fold.
 Implications for current generation?
A typical college student today will earn a lifetime

income about twice his or her parents.
 How about current generation in Bangladesh?
INCOME AROUND THE WORLD
PER CAPITA GDP: COMPARISON BETWEEN BANGLADESH
AND THE UNITED STATES
THE DEFINITION OF ECONOMIC GROWTH
 Growth of per capita GDP : The exact rate of change of per
capital GDP
 A percentage change : The change between two periods
divided by the value of the variable in the initial period
 Percentage change in GDP between period t and t + 1
= 𝑦𝑡+1 − 𝑦𝑡 /𝑦𝑡
Where 𝑦𝑡+1 represents new GDP and 𝑦𝑡 represents old GDP.
 Finding the growth rate between that same period
𝑦𝑡+1 = 𝑦𝑡 1 + 𝑔
A POPULATION GROWTH EXAMPLE
 Population (L below) also works this way.
𝐿𝑡+1 = 𝐿𝑡 (1 + 𝑛)
 Intuitively, tomorrow’s population in time

period (t + 1) depends on today’s population in
period, t.
THE RULE OF 70
 The constant growth rule:
𝑦𝑡 = 𝑦0 1 + 𝑔 𝑡
 where 𝑦𝑡 is the value of the variable in period t, 𝑦0 is the value
in the initial period and 𝑔 is the constant growth rate.
The Rule of 70
If y grows at a rate of g percent per year, then the number of
years it takes y to double is approximately equal to 70/g.
 Notes
• Small differences in growth rates result in large differences over
time.
• The time it takes to double only depends on the growth rate
and not the initial value
THE RULE OF 70
A RATIO SCALE
 Plot where equally spaced tick marks on the vertical
axis are labeled consecutively with numbers that
exhibit a constant ratio
When plotted on a ratio scale, a variable that grows
at a constant rate will be a straight line.
U.S. GDP on a Ratio Scale:
• Per capita GDP in the United States has grown at
approximately 2 percent per year over the last 130
years.
• Easy to see with a ratio scale
• Approximately linear
A RATIO SCALE: POPULATION
A RATIO SCALE: REAL GDP PER CAPITA
CALCULATING GROWTH RATES
The rule for computing growth rates
𝑡
𝑦𝑡 = 𝑦0 1 + 𝑔
Solve for the growth rate,

1
𝑦𝑡 𝑡
𝑔= -1
𝑦𝑜
This formula can be applied even if the data does
not exhibit constant growth.
MODERN GROWTH AROUND THE WORLD:
CONVERGENCE VS DIVERGENCES HYPOTHESIS
After World War II, growth in Germany and Japan

accelerated.
• Convergence
• Poorer countries will grow faster to “catch up” to
the level of
income in richer countries.
• Brazil had accelerated growth until 1980 and
then stagnated.
• China and India have had the reverse pattern.
DO ECONOMIES CONVERGE?
MODERN GROWTH AROUND THE WORLD:
CONVERGENCE VS DIVERGENCES HYPOTHESIS
SOME USEFUL PROPERTIES OF GROWTH RATES
Growth rates of ratios, products, and powers follow

several simple rules.
• Growth rates obey mathematical operations that are a
level simpler than the operation on the original variable.
• Variables divided → growth rates subtracted
• Variables multiplied → growth rates added
• Variable taken to a power number → growth rate
multiplied by that number
SOME USEFUL PROPERTIES OF GROWTH RATES
o Suppose two variables 𝑥 and 𝑦 have average annual
growth rates of 𝑔𝑥 and 𝑔𝑦, respectively.
oAssume also that 𝑔𝑧 is the average annual growth rate
of 𝑧.
oThen the following rules apply:
𝑥
1. 𝐼𝑓 𝑧 = , 𝑡ℎ𝑒𝑛 𝑔𝑧 = 𝑔𝑥 - 𝑔𝑦
𝑦
2. 𝐼𝑓 𝑧 =(𝑥 × 𝑦), 𝑡ℎ𝑒𝑛 𝑔𝑧 = 𝑔𝑥 + 𝑔𝑦
3. 𝐼𝑓 𝑧 = 𝑥 𝑎 , 𝑡ℎ𝑒𝑛 𝑔𝑧 = 𝑎 × 𝑔𝑥
GROWTH RULES IN A FAMOUS EXAMPLE
One of the key equations of macroeconomics relating output and
factors of production(Growth accounting) can be explained as:
𝑌𝑡 = 𝐴𝑡 𝐾𝑡 𝛼 𝐿𝑡 𝛽 (1)
where, Y is the output, L and K refers to labor and capital
respectively. 𝛼 represents the output elasticity of capital, while 𝛽
is the output elasticity of labor respectively, and (𝛼+ 𝛽 =1). A is
the total productivity.
Taking log in both side of equation-1,
Log(𝑌𝑡 ) = log(𝐴𝑡 ) + 𝛼 log𝐾𝑡 + 𝛽 log𝐿𝑡 (2)
From equation-2,
g(𝑌𝑡 ) = g(𝐴𝑡 ) + 𝛼g(𝐾𝑡 ) + 𝛽g(𝐿𝑡 ) (3)
THE COSTS OF ECONOMIC GROWTH
The benefits of economic growth
• Improvements in health
• Higher incomes
• Increase in the variety of goods and services
• Costs of economic growth include:
• Environmental problems
• Income inequality across and within countries
• Loss of certain types of jobs
• Economists generally have a consensus that the
benefits of economic growth
outweigh the costs.

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ECO302:

Lecture-3: Long-Run Economic Growth

Instructor: Biplob Nandi

 Long-run growth is defined as the sustained rise in

Source: WDI, World Bank

 Understanding the long-run economic growth, we have to

BGD CHN IND Rwanda

Source: WDI Data, World Bank

 The recent era of increased difference in standards

A typical college student today will earn a lifetime

 Intuitively, tomorrow’s population in time

Solve for the growth rate,

After World War II, growth in Germany and Japan

Growth rates of ratios, products, and powers follow

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