Light bulbs. When I teach growth theory, I just keep talking about the difference between out of steady-state growth and steady-state growth until I see light bulbs. It seems esoteric at first, this distinction.
Capital accumulation explains growth up until the economy gets to the steady-state. Every economy eventually gets to the steady-state. Economies don’t stop growing.
“What the hell is the steady-state!?” you hear their expressions saying (when they’re not scribbling notes furiously as “this will be on the test”).
Capital has diminishing returns — the pizza joint only needs so many ovens — but it breaks at a constant rate — pizza guy expects to repair 10% of his oven every year (or he expects to replace his oven every 10 years). This means as additional bits of capital are added to the economy, less and less of them add to the total stock of capital and more and more of it is used to replace broken capital.
“Ack! ‘diminishing returns’! That’s definitely going to be on the final!” Scribble, scribble.
If more of that investment is going to adding new capital than is being used to replace old capital, more capital is being added to the economy. More capital means more output.
“Wait. Investment? I thought we were talking about savings.” (At which point, I hope the Smart Kid ™ asks about why we can assume savings is constant over all income levels. He doesn’t.)
Eventually, this sort of income growth peters out as we get closer to the level of capital where the amount of new capital exactly equals the amount of capital that is breaking; the steady state. Fingers, hands, arms, pants, backpack and that woman’s coat get a fine coat of chalk dust as I inch my way through the dynamics on the Solow diagram.
The first question comes, “what’s that line on the diagram mean?” (Doh!… but I use the opportunity to repeat the dynamics story, trying to emphasize the diminishing role of capital in growth… there’s a singular level of capital the economy is headed towards.)
more *binging* *ponging* and *dinging*
The next and next questions give me the opportunity to try to explain the story in different words, from different angles. Rinse and repeat ((not kidding, during last quarter’s final review session, the same question was asked 5 different times in succession by different people… I happily obliged; there’s no diminishing returns to lighting light bulbs)).
And then, when the density of lit light bulbs is sufficiently high (I shoot, aggressively, for 25% coverage), I hit them with: “We think the U.S. is near the steady-state level of capital because capital been at about 2.5 times GDP for over a hundred years. Yet, the U.S. GDP has been growing at about 2% a year for just as long. How can this be? How can we have income growth if the number of machines in the economy isn’t changing?”
“Technological improvements!” shouts Smart Kid ™, “They make capital more productive.”
Ah, light bulbs!
Now, did Smart Kid, and hopefully at least some others, learn anything about growth? YouNotSneaky! thinks so. In any case, I certainly hope so because it feels a hell of a lot like I’m teaching!