The World Economy

Total GDP (2012): $83T

Population (2012):7B
GDP per Capita (2012): $12,500
Population Growth (2012): 1.1%
GDP Growth (2012): 3.3%
GDP per capita is probably the best measure of a countrys overall well
being
Region GDP % of
World
GDP
GDP Per
Capita
Real GDP
Growth
United States $15T 18% $48,000 1.3%
European Union $16T 19% $33,000 1.0%
Japan $4.3T 6% $34,200 -.4%
China $7.8T 11% $6,000 9.8%
India $3.2T 5% $2,800 6.6%
Ethiopia $66.3B .09% $800 8.5%
Note. However, that growth rates vary significantly across countries/regions. Do
you see a pattern here?
Source: CIA World Factbook
At the current trends, the standard of living in China will surpass that of the
US in 25 years! Or, will they?
P
e
r

C
a
p
i
t
a

I
n
c
o
m
e

That is, can China maintain its current growth rate?
Income GDP/Capita GDP Growth
Low $510 6.3%
Middle $2,190 7.0%
High $32,040 3.2%
As a general rule, low income (developing) countries tend to have
higher average rates of growth than do high income countries
The implication here is that eventually, poorer countries should
eventually catch up to wealthier countries in terms of per capita income
a concept known as convergence
Some countries, however, dont fit the normal pattern of development
Sudan
GDP: $80B (#80)
GDP Per Capita: $2,400 (#184)
GDP Growth: -11.2% (#219)
Qatar
GDP: $150B (#59)
GDP Per Capita: $179,000 (#1)
GDP Growth: 16.3% (#1)
So, what is Sudan doing wrong? (Or, what is Qatar doing right?)
At current trends, Per capita income in Qatar will quadruple to
$716,000 over the next decade. Over the same time period, per
capita GDP in Sudan will drop by roughly 40%to $670!!!
To understand this, lets look at the sources of economic growth.where
does production come from?
( ) L K A F Y , , =
Real GDP
is a function of
Productivity
Capital
Stock
Labor
Real GDP = Constant Dollar (Inflation adjusted) value of all goods and
services produced in the United States

Capital Stock = Constant dollar value of private, non-residential fixed assets

Labor = Private Sector Employment

Productivity = Production unaccounted for by capital or labor
A convenient functional form for growth accounting is the Cobb-Douglas
production function. It takes the form:
| o
L AK Y = where
1 = + | o
With the Cobb-Douglas production function, the parameters have
clear interpretations:
Capitals share of income (what %
of total income in the US accrues to
owners of capital)
Labors share of income (what % of
total income in the US accrues to
owners of labor)

Elasticity of output with respect to
capital (% increase in output
resulting from a 1% increase in
capital)
Elasticity of output with respect to
labor (% increase in output resulting
from a 1% increase in labor)
o
|
3
2
3
1
L AK Y =
Suppose we have the following Cobb-Douglas production function:
A 1% rise in
employment raises
GDP by 2/3%
A 1% rise in capital
raises GDP by 1/3%
We can rewrite the production function in terms of growth rates to
decompose GDP growth into growth of factors:
( ) ( ) ( ) L K A Y A + A + A = A %
3
2
%
3
1
% %
Real GDP Growth
(observable) Employment
Growth
(observable)
Capital Growth
(observable)
Productivity Growth
(unobservable)
Year Real GDP (Billions of
2000 dollars)
Real Capital Stock
(Billions of 2000 dollars)
Employment (thousands)
1939 1,142 1,440 29,923
2006 11,257 12,632 135,155
2007 11,467 12,883 137,180
Lets decompose some recent data first
( ) ( ) | | 85 . 1 100 * 257 , 11 ln 467 , 11 ln % = = AY
( ) ( ) | | 97 . 1 100 * 632 , 12 ln 883 , 12 ln % = = AK
( ) ( ) | | 48 . 1 100 * 155 , 135 ln 180 , 137 ln % = = AL
Note that capital is
growing faster than
employment
( ) ( ) 20 . 48 . 1
3
2
97 . 1
3
1
85 . 1 % = = AA
Year Real GDP (Billions of
2000 dollars)
Real Capital Stock
(Billions of 2000 dollars)
Employment (thousands)
1939 1,142 1,440 29,923
2006 11,257 12,632 135,155
2007 11,467 12,883 137,180
Now, lets look at long term averages
( ) ( ) | |
39 . 3 100 *
68
142 , 1 ln 467 , 11 ln
% =

= AY
( ) ( ) | |
22 . 3 100 *
68
440 , 1 ln 883 , 12 ln
% =

= AK
( ) ( ) | |
23 . 2 100 *
68
923 , 29 ln 180 , 137 ln
% =

= AL
( ) ( ) 84 . 23 . 2
3
2
22 . 3
3
1
39 . 3 % = = AA
1939 - 1948 1948 - 1973 1973-1993 1993-2007
Output
5.79 4.10 1.96 2.63
Capital
3.34 4.24 2.10 2.94
Labor
4.46 2.10 1.86 1.60
Productivity 1.71 1.28 0.02 0.59
A few things to notice:
Real GDP growth is declining over time.
Capital has been growing faster than labor
The contribution of productivity is diminishing!
Contributions to growth from capital, labor, and technology vary across time
period
Our model of economic growth begins with a production function
Real GDP
Productivity
Capital
Stock
Labor
Given our production function, economic growth can result
from
Growth in Labor
Growth in the capital stock
Growth in Productivity
3
2
3
1
L AK Y =
We are concerned with capital based growth. Therefore, growth in productivity
and employment will be taken as given
Productivity
grows at rate
A
g
Pop
Pop
LF
LF
L
L
|
|
.
|

\
|
|
.
|

\
|
=
Population
grows at rate
L
g
Employment
Labor Force
= Employment Ratio
( Assumed Constant)
Labor Force
Population
= Participation rate
( Assumed Constant)
3
2
3
1
L AK Y =
Our simple model of economic growth
begins with a production function with
one key property
Y
K
) , , ( L K A F
As the capital stock
increases (given a fixed
level of employment), the
productivity of capital
declines!!
K
Y
MPK
A
A
=
Change in Capital Stock
Change in Production
An economy cant grow through capital accumulation alone forever!
3
2
3
1
L AK Y =
K A
Y A
K A
Y A
Everything in this model is in per capita terms
3
2
3
1
L AK Y =
Divide both sides by labor to represent our variables in per capita terms
3
1
3
1
3
2
3
1
3
2
3
1
Ak
L
K
A
L L
L AK
L
Y
y =
|
.
|

\
|
= = =
Capital Per Capita
Productivity
Per capita
output
In general, lets assume lower case letters refer to per capita variables