Lecture 2

• Objects are capital and Labour from the solow model. They are finite
• ideas are the items used in making objects, are virtually infinite and are non-rivalry
• Smiths invisible hand theorem states that perfectly competitive markets lead to the best possible outcome, because At, Kt, and Lt all have decreasing returns to scale
• The ideas theory doesn’t follow Smiths theory because idea s are non rival, so have increasing returns to scale, so pure competition results in market failure
• Objects are rivalrous, as one persons use reduced its utility to someone else
• Ideas are nonrivalrous, as one persons use doesn’t reduce i it’s utility to someone else
• ideas are excludable, as legal restrictions can be implemented on their use
• Increasing returns to scale means that the average production per pound spent rises as scale of production increases; average cost decreases as production increases
• Increasing returns to scale means that it is expensive to come up with new ideas due to high initial development costs
• Constant returns to scale is implied with the standard replication argument
• Ideas need to be protected, as otherwise someone can use an idea that someone pays allot of money to develop for free, and have no fixed development costs and so can out compete the developer
• The Romer model distinguishes between ideas and objects
• According to Romer, new ideas depend on the ideas from the previous period, the number of workers producing ideas, and workers productivity
• Unregulated markets underprovides ideas
• Lat is the number of people employed to produce new ideas
• Lyt is the number of workers producing output
• Lat + Lyt = L
• The solow model states that the output per person depends on capital per person
• Romer states that the stock of knowledge depends on its initial value and its growth rate
• At= A0(1 + g)^t
• The Romer model involves constant growth
• The Romer model is different to the Solow model, as Romer involves constant growth, and Solow only uses transitory growth
• Standard replication in the solow model means that capital has diminishing returns
• The Romer model states that Labour and ideas have increasing returns together, and that returns to ideas are unrestricted
• The Romer model has a balanced growth path, which is not a steady state, but is a stable growth level
• Each country has a different balanced growth path
• The Romer model doesn’t show transition dynamics, as there is no capital accumulation
• In the Romer model, population has no direct impact on y, because y is per-capita output. However, indirectly, it impacts the growth path
• population growth increases L, which increases g. This shifts the balanced growth path and results in a faster growth rate o f y
• The rate of growth of an economy being dependent on population size is unrealistic when comparing individual economies, but is true when looking at the global economy
• If rate of growth was dependent on population size, the US would have a much higher growth than Luxembourg, as they have more researchers than Luxembourg has people
• Because ideas are non-rivalrous, all countries can benefit from new ideas no matter where they originate, so a larger country size doesn’t necessarily result in much higher growth rates
• An increase in proportion of people creating ideas will cause a temporary reduction in y, as there are fewer people creating output, but this is quickly compensated for by the higher growth rate
• Growth effects come from changes to the rate of growth of y (per capita output)
• Level effects are changes in the level of per capita GDP
• Romer uses growth and level effects
• Solow only uses level effects
• The degree of increasing returns matters for growth effects, as is the exponent on ideas (At) is not 1, there will still be sustained growth, but growth effects are eliminated
• Not all data supports Romer, as increases in L and Lat can result in reductions in Z over time, because it’s more difficult to find new ideas
• The combination of the Solow and Romer models means that for sho rt periods of time, countries grow at different rates (Solow), but in the long run, countries grow at the same rate (Romer)