Modern Principles: Macroeconomics

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Oct 28, 2013 (4 years and 11 days ago)

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Solow Growth Model
:
Modern Principles
:

Macroeconomics


Cowen
and
Tabarrok’s
Modern Principles: Macroeconomics

presents a wonderful opportunity to bring
modern growth coverage and theory into the principles class. Because of the inclusion of the Solow
model

it does present a challenge with that opportunity. We truly believe that Solow is presented in an
appropriate level for principles and the benefits of including it outweigh the challenges.


We realize not all instructors will teach the entire Model as it

is presented. In fact we realize some
instructors will want to minimize the coverage of it entirely while still teaching the wonderful growth
lessons presented in
Modern Principles: Macroeconomics
.


This document is designed to illustrate the flexibility
of this coverage.

1) Why teach the Solow growth model?

We want students who read the Modern Principles to be able to answer three paradigmatic questions.



Why is South Korea richer than North Korea?



Why is China growing faster than the United States?



Wha
t determines the growth rate of the country (or countries) on the cutting edge?

The first question is covered in Chapter 6 and involves incentives and institutions
(property rights,
corruption, the rule of law
, and so forth; in essence
everything the stude
nt has
learned about the
invisible hand plus

political economy
)
.

Answering the first question, however, naturally raises a second question. Why is China growing so
much faster than the United States? After all, on every score China has worse institutions

and incentives
than the United States. Indeed, if the student is not puzzled by this question he or she may draw

precisely the wrong conclusion
--
reasoning that if China is growing quickly it must be because i
t has good
institutions. T
his type of error i
s very common. When Germany and Japan were growing more quickly
than the United States
many observers
point
ed

to the German labor system or Japanese "cooperative
capitalism" as the key institutions that the US needed and di
d not have. T
hese institutions
may or not
be growth enhancing but the key point is that one shouldn't compare growth rates without first
correcting for catch
-
up, the fact that capital in poorer economies tends to be more productive because
capital per worker is low.

We cover
diminishi
ng returns to capital
and its importance in the first section of Chapter 7. Diminishing
returns alone
takes us quite far in answering the China question. If we add capital depreciation to the
mix we can arrive at a second

important

conclusion. Capital a
lone cannot explain growth in the long
run. At this stage, we have covered the key elements of the Solow model and we leave it to the
instructor to pursue one of two paths. Finish the Solow model by discussing changes in saving rates and
so forth. An in
structor who follows this path usefully ties growth
to
the chapters on financial
intermediation.
We have made the material simple enough so that it can be taught to principles
students but
,

there are diminishing returns in all things
,

so an instructor ma
y want to allocate more time
to other topics.
Alternatively, an instructor

can follow through on the conclusion that capital alone
cannot explain growth in the long run to ask
, W
hat does

explain growth in the long run
?

Alternatively
stated, W
hat determin
es the rate of growth of the cutting edg
e countries?

The cutting edge countries are the countries that cannot grow much by adding capital (since returns are
low and depreciation of the already existing capital stock is high) and so must grow by
increasing

the
productivity of a given supply of capital.
We cover the economics of ideas
in the second half of Chapter
7.

Together Chapters 6 and 7
give the student a very good grounding in economic growth, both for the
citizen and for the student continuing on in
economics. We think that the importance of economic
growth for human welfare and the value of the unique insights offered by economists
on this topic
more
than justify the careful attention given to this material in
Modern Principles
.

2)

If I teach the Solow

growth model, do I have to teach it in
-
depth?


No. As is said in the preface:



The second option is to cover only a portion of the Solow model in Chapter 7.

We sometimes do this in our larger classes so this will be a good choice for many.

The chapter h
as been written so the most intuitive and important aspects of the

model are covered in the beginning, more difficult and detailed material in the

middle may be skipped, and then important material on growth and ideas is covered

toward the end of the chapt
er. The material in the middle may be skipped

without loss of continuity. Instructors with smaller and more advanced classes can

easily cover the full chapter. The instructor’s guide written by John Dawson offers

many excellent tips for covering this mater
ial



Specifically, you can
skip pages 124


130, as we sometimes do in our larger classes.


3) Do

I have to teach the Solow model at all?

No. Again, from our preface:

One important point: it is not at all necessary to teach the Solow model to cover

our c
hapters on business fluctuations. We offer a “Solow growth curve” in these

chapters, but without delving into the details of the Solow model, the curve is readily

explained as a potential growth curve analogous to a potential GDP curve.


Specifically, on p
age 243, we state:

We learned in Chapters 6 and 7 that economic growth depends on increases in

the stocks of labor and capital and on increases in productivity (driven by new

and better ideas and better institutions). Thus, the economy has a potential

grow
th rate given by these fundamental or real factors of production. If markets

are working well and prices are flexible, then an economy will grow at its

potential rate. In other words, when prices are flexible, actual growth will be

equal to potential growt
h. But, we will see later that all prices are not perfectly

flexible; in the short run some prices, especially wages, can be “sticky” and because

of this an economy need not always be growing at its potential.


We call it the Solow growth curve because Rob
ert Solow, one of the giants

of economics, created an important model of an economy’s potential growth

rate. In Chapter 7, we described Solow’s model in more detail, but if you

skipped that section don’t worry; just think of the
Solow growth rate
as the

ra
te of economic growth given flexible prices and the existing real factors of

capital, labor, and ideas.


Thus, you can teach the intuitive growth concepts presented in Modern Principles: Macroeconomics and
introduce the Solow model without actually going i
nto depth as we do in Chapter 7.