War Simulator

The Neoclassical Growth Model

The neoclassical growth model is derived from the Cobb Douglas production function $$Y_{t} = A K_{t}^\alpha L_{t}^{1-\alpha} $$ where $$Y = Output$$ $$A = Total Factor Productivity$$ $$K = Capital$$ $$L = Labor$$ $$\alpha = Production \: elasticity \: of \: capital \: and \: capital \: income \: share \: under \: perfect \: competition$$ $$1-\alpha = Production \: elasticity \: of \: labor \: and \: labor \: income \: share \: under \: perfect \: competition$$ $$t=time$$ Because of linear homogeneity, which is that $$mY_{t}= A (\, mK )\,_{t}^\alpha (\, mL )\,_{t}^{1-\alpha}$$ and setting m=1/L, it follows that $$y_{t}=Ak_{t}^\alpha$$ where $$y_{t}=output \: per \: worker$$ $$k_{t} = capital \:per\: worker$$ The production function is called “neo-classical” because it embeds the assumption of positive, but diminishing returns to capital per labor. This is, $$ \frac{\partial y_{t}}{\partial k_{t}} = \alpha A k_{t}^{\alpha-1} > 0$$ $$ \frac{\partial y_{t}}{\partial k_{t}} = \alpha (\, \alpha - 1 )\, A k_{t}^{\alpha-2} > 0$$ The neo-classical production function needs to be distinguished from the Keynesian production function, which is linear. The standard Keynesian growth model is the so-called Harrod-Domar model and assumes a linear relationship between capital and output (Van den Berg, 2001). The problem with linear production functions, however, is that they only apply to short-run dynamics of unemployment.

The shape of a neoclassical production function is illustrated in Figure 1.

Figure 1: The Neoclassical Production Function

In order to see what dynamics the neoclassical production function follows over time, the derivative of the per capita production function with respect to time is taken. This is, $$\dot{y}_{t} = A f^\prime (k_{t}) \frac{d k_{t}}{d K_{t}} \frac{d K_{t}}{dt} + A f^\prime (k_{t}) \frac{d k_{t}}{d L_{t}} \frac{d L_{t}}{d t} = A f^\prime (k_{t}) (\frac{1}{L_{t}}\dot{K}_{t} - \frac{K_{t}}{L_{t}^2}\dot{L}_{t})$$ Since $$\dot{K}_{t}= s Y_{t} - \delta K_{t}$$ which is savings minus capital depreciation, where $$s= savings \: rate$$ $$\delta = capital\:depreciation\: rate$$ and $$\dot{L}_{t}=n L_{t}$$ which is the population growth rate, where $$n=population\:growth\:rate$$ it follows that $$\dot{y}_{t}=A f^\prime (k_{t})[sy_{t}-(n+\delta)k_{t}]$$ where $$A f^\prime (k_{t}) = marginal\: product \: of\:labor$$ Important is now the term \( [sy_{t}-(n+\delta)k_{t}] \), which is the so-called Solow equation, and from which the growth dynamics can be derived. They are illustrated in Figure 2.

Figure 2: Solow Growth Model

Output per worker grows whenever \( [sy_{t} > (n+\delta)k_{t}] \) and declines whenever \( [sy_{t} > (n+\delta)k_{t}] \). The Solow growth model suggests that GDP per capita inevitably reaches a steady state at which output per capita stays constant. This is the case at k*. Of course, more advanced economic growth models can circumvent the problem of a steady state. These are so-called growth models with exogenous technological progress or, more sophisticatedly, endogenous growth models.

Simulating the Effects of War on Economic Growth

In order to illustrate the impacts of war on economic growth, I start with a simple model that can be easily solved. The model assumes:
\( y=Ak^\alpha \), where \( A=1 \), \( k=10 \), and \( \alpha = 0.5 \)
\( n=0.025 \)
\( \delta = 0.1 \)
\( s=0.5 \)
In this model the steady state capital stock is k*=16 and the associated steady state income y*=4.

Holding everything else constant, the steady state can also be dynamically simulated using the following formula: $$ k_{t}=k_{t-1}+s_{t-1}y_{t-1}-(n+\delta)k_{t-1} $$ Assuming \(k_{t=0}=10 \), then it takes 60 periods until a steady state is reached (I assume a steady state when the per capita net capital formation falls below 0.01).

In order to illustrate the effects of war on economic growth, I assume the following:

Thus, for t=60, above equation becomes in the simulation scenario $$ k_{t-1} = k_{t=59} (\, \frac{1-capital\: destruction (\, \% )\,}{1-people\: killed(\, \% )\,} )\, + s_{t=60}^{post\:war} \times y_{t=59} - (\, n_{t=60}^{post\:war} + \delta_{t=60}^{post\:war} )\, k_{t=59} $$ and for \(t\leq61\) again above equation with the new parameters.

The Application

Total Factor Productivity
Population Growth Rate
Capital Desctruction
People killed