ECO403 Final Term Notes by Iqra Azhar

Rana Abubakar Khan

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JOIN FB GROUP FOR VU HELP · NOTES AND FORMULAS OF MACROECONOMICS · LEC 23-45 · ENDOGENOUS GROWTH THEORY

Production function for endogenous growth model can be written as: Y = A K, Where A is the amount of output for each unit of capital (A is exogenous & constant). Investment: sY Depreciation: δK Equation of motion for total capital: ΔK = s Y − δ K Divide through by K and use Y = A K, get:

ΔY = ΔK = s A −δ

Y K

If s A >δ, then income will grow forever, and investment is the “engine of growth.” Here, the permanent growth rate depends on s. In Solow model, it does not.

A TWO-SECTOR MODEL

u = fraction of labor in research (u is exogenous)

•  Manufacturing production function:

Y = F [K, (1-u) E L]

•  Research production function:

Δ E = g (u) E

•  Capital accumulation:

Δ K = s Y − δ K

•  In the steady state, manufacturing output per worker and the standard of living grow at rate:

ΔE/E = g (u). Key variables are: s: affects the level of income, but not its growth rate (same as in Solow model) u: affects level and growth rate of income

TIME HORIZONS

• Long run: Prices are flexible, respond to changes in supply or demand
• Short run: many prices are “sticky” at some predetermined level

The economy behaves much differently when prices are sticky.

AGGREGATE DEMAND

The aggregate demand curve shows the relationship between the price level and the quantity of output demanded. For an intro to the AD/AS model, we use a simple theory of aggregate demand based on the Quantity Theory of Money.

THE QUANTITY EQUATION AS AGGREGATE DEMAND

Quantity equation: M V = P Y The money demand function it implies: (M/P) d = k Y, Where V = 1/k = velocity. For given values of M and V, these equations imply an inverse relationship between P and Y.

THE DOWNWARD-SLOPING AD CURVE

An increase in the price level causes a fall in real money balances (M/P), causing a decrease in the demand for goods & services.

SHIFTING THE AD CURVE

An increase in the money supply shifts the AD curve to the right.