Chapter 25: The Difference Between Short-Run and Long-Run Macroeconomics Copyright © 2014 Pearson Canada Inc.

Chapter Outline/Learning Objectives Section Learning Objectives After studying this chapter, you will be able to 25.1Accounting for Changes in GDP 2.understand how any change in real GDP can be decomposed into changes in factor supply, the utilization rate of factors, and productivity. 3.understand that short-run changes in GDP are mostly caused by changes in factor utilization, whereas long- run changes in GDP are mostly caused by changes in factor supplies and productivity. 25.2Policy Implications4.explain why macroeconomic policies will only have a long-run effect on output if they influence the level of potential output. Copyright © 2014 Pearson Canada Inc. Chapter 25, Slide 2

25.2Accounting for Changes in GDP GDP Accounting: The Basic Principle Consider the following identity: GDP = F x (F E /F) x (GDP/F E ) F is the amount of factors F E is the amount of employed factors What are the three separate terms? Copyright © 2014 Pearson Canada Inc. 3 Chapter 25, Slide

GDP = F x (F E /F) x (GDP/F E ) 1.F is the factor supply. 2.F E /F is the factor utilization rate. 3.GDP/F E is a simple measure of productivity. Any change in GDP must be associated with a change in one or more of these things. How do these three components change over time? Copyright © 2014 Pearson Canada Inc. 4 Chapter 25, Slide

1.Factor Supplies Supplies of labour and capital change only gradually 2.Productivity Productivity changes only gradually 3.Factor Utilization Rate Fluctuates a lot in the short run But very little in the long run Copyright © 2014 Pearson Canada Inc. 5 Chapter 25, Slide

GDP Accounting: An Application Consider just one factor of production—labour. The identity becomes: GDP = L x (E/L) x (GDP/E) L is the labour force E/L is the employment rate GDP/E is a simple measure of labour productivity How have these components actually moved in Canada? Copyright © 2014 Pearson Canada Inc. 6 Chapter 25, Slide

Fig Three Sources of Changes in GDP 7 Copyright © 2014 Pearson Canada Inc. Chapter 25, Slide

Summing Up To understand long-run changes in GDP: need to understand labour force growth and productivity growth To understand short-run changes in GDP: need to understand changes in the utilization rate of labour—the employment rate Copyright © 2014 Pearson Canada Inc. 8 Chapter 25, Slide

25.3Policy Implications Fiscal and monetary policies affect the short run level of GDP because they alter the level of aggregate demand. But unless they are able to affect the level of potential output, they will have no effect on long-run GDP. broad consensus that monetary policy has only limited effects on Y* fiscal policy probably has more effects on Y* Copyright © 2014 Pearson Canada Inc. 9 Chapter 25, Slide

Review GDP can be represented by the equation: GDP = L x [E/L] x [GDP/E] where L is the total supply of labour and E is the level of employment. In this equation, the term [GDP/E] represents A) output per unit of capital. B) the productivity of labour. C) the unemployment rate. D) the ratio of the population unemployed. E) one minus the unemployment rate. 10 © 2014 Pearson Education Canada Inc.

Review Consider a small economy where factor supply is 1000 units, the factor utilization rate is 0.9 and a simple measure of productivity (GDP per factor employed) is $80. This economy's GDP is A) $ B) $ C) $7200 D) $ E) $ © 2014 Pearson Education Canada Inc.

Chapter 26: Long-Run Economic Growth Copyright © 2014 Pearson Canada Inc.

Chapter Outline/Learning Objectives Section Learning Objectives After studying this chapter, you will be able to 26.1The Nature of Economic Growth 1.discuss the costs and benefits of economic growth. 2.list four important determinants of growth in real GDP. 26.2Established Theories of Economic Growth 3.explain the main elements of Neoclassical growth theory in which technological change is exogenous. 26.3Newer Growth Theories 4.discuss alternative growth theories based on endogenous technical change. 26.4Are There Limits to Growth? 5.explain why resource exhaustion and environmental degradation may create serious challenges for public policy directed at sustaining economic growth. Copyright © 2014 Pearson Canada Inc. 13 Chapter 26, Slide

26.1The Nature of Economic Growth Sustained increases in Y* are a more powerful method of raising material living standards than the removal of recessionary gaps. Even small differences in annual growth rates can result in large changes in living standards after many years. Consider GDP, per capita GDP, and GDP per worker. Copyright © 2014 Pearson Canada Inc. 14 Chapter 26, Slide

Measuring Growth A growth rate is the annual percentage change of a variable. One measure of economic growth is Real GDP Growth Rate. Real GDP Growth Rate = Real GDP t – Real GDP t-1 X 100 Real GDP t-1 The growth rate of real GDP tells us how rapidly the TOTAL economy is expanding. 15 © 2014 Pearson Education Canada Inc.

Per Capita Real GDP To determine if a country's standard of living is improving, economist use Real GDP per capita. Real GDP Per Capita = Real GDP Population The contribution of Real GDP growth to the change in standard of living depends on the growth rate of of Real GDP Per Capita. Real GDP/Capita Growth = Real GDP/capita t – Real GDP/capita t-1 X 100 Real GDP t-1 Real GDP per capita grows only if the real GDP grows fater than the population! 16 © 2014 Pearson Education Canada Inc.

What Determines Potential GDP? As we saw in Chapter 25, land, labour, capital (and entrepreneurship) produce Real GDP, and the productivity of the factors determines the amount of Reap GDP that can be produced. Labour productivity is the quantity of real GDP produced by an hour of labour. Labour Productivity = = Real GDP Aggregate labour hours Example: if real GDP is $1,400 Billion and aggregate labour hours are 20 billion, then labour productivity is $65 per hour. 17 © 2014 Pearson Education Canada Inc.

Conditions for Labour Productivity Growth 1.Physical Capital Growth - As the amount of capital per worker increases, labour productivity also increases 2.Human Capital Growth - Remember human capital is the accumulated skill and knowledge of human beings 3. Technological Advances - the discovery and application of new technologies has contributed greatly to labour productivity - technological advances arises from formal research and development programs, trial and error, and discovering new ways to get more out of our resources 18 © 2014 Pearson Education Canada Inc.

Benefits of Economic Growth 1.Rising average living standards 2.Alleviation of poverty many do not share directly in the growth but redistribution is easier in a growing economy 19 Copyright © 2014 Pearson Canada Inc. APPLYING ECONOMIC CONCEPTS 26-1 A Case Against Economic Growth Chapter 26, Slide

Costs of Economic Growth 1.Sacrifice of Current Consumption growth is often encouraged by increasing investment and saving which requires less consumption 2.Social Costs of Growth growth usually involves the displacement of some firms and workers this process involves real transition costs 20 Copyright © 2014 Pearson Canada Inc. Chapter 26, Slide

Sources of Economic Growth The four fundamental sources of economic growth are: 1.Growth in the labour force 2.Growth in human capital 3.Growth in physical capital 4.Technological improvement Different theories emphasize different sources of growth. 21 Copyright © 2014 Pearson Canada Inc. Chapter 26, Slide

Neoclassical Growth Theory This theory begins with the idea of an aggregate production function: GDP = F T (L,K,H) L is the total amount of labour K is the stock of physical capital H is the quality of human capital T is the state of technology The notation F T reflects the assumption that changes in technology will change the production function. 22 Copyright © 2014 Pearson Canada Inc. Chapter 26, Slide

In the Neoclassical growth model, technological change is necessary for sustained growth in living standards. Much technological change is embodied in new capital equipment  investment is crucial Measuring the extent of technological change is difficult—because it is not directly observable. 23 Copyright © 2014 Pearson Canada Inc. Chapter 26, Slide

Robert Solow (MIT) his "growth accounting" method estimates technical change as the part of growth that is unexplained by capital accumulation or labour-force growth.  the "Solow Residual" 24 Copyright © 2014 Pearson Canada Inc. LESSONS FROM HISTORY 26-1 Should Workers Be Afraid of Technological Change? Chapter 26, Slide

26.3Newer Growth Theories Endogenous Technological Change New growth theory emphasizes the process of innovation and the incorporation of new technology: learning-by-doing knowledge transfer market structure and innovation shocks and innovation Copyright © 2014 Pearson Canada Inc. 25 Chapter 26, Slide

Increasing Marginal Returns New growth theories also emphasize the possibility that each new increment of investment is more productive than the last. contrasts with the Neoclassical assumption of diminishing marginal returns. The sources of increasing returns usually fall into one of two categories: market-development costs increasing returns to knowledge 26 Copyright © 2014 Pearson Canada Inc.

26.4Are There Limits to Growth? Resource Exhaustion Current technology and resources could not support the entire world's population at the average Canadian standard of living. but absolute limits to growth may not be relevant technology is constantly improving, suggesting that living standards can continually improve but technological improvements are not automatic— they do not "just happen" Copyright © 2014 Pearson Canada Inc. 27 Chapter 26, Slide

Environmental Degradation Conscious management of pollution was unnecessary when the world's population was one billion people, but such management has now become a pressing matter. Conclusion Growth can help the world address many problems. But further growth must be sustainable growth, which should be based on knowledge-driven technological change. 28 Copyright © 2014 Pearson Canada Inc. Chapter 26, Slide APPLYING ECONOMIC CONCEPTS 26-2 Climate Change and Economic Growth

Review A person who returns to school to improve her computer skills is an example of an increase in A) technological capital. B) the labour force. C) physical capital. D) financial capital. E) human capital. 29 © 2014 Pearson Education Canada Inc.

Review In the Neoclassical growth model, if capital and labour grow at the same rate, we will observe A) increasing living standards but only for workers using capital- intensive production. B) rising GDP and increasing living standards. C) increasing living standards but only for workers using labour- intensive production. D) rising GDP but no change in living standards. E) rising GDP but falling living standards. 30 © 2014 Pearson Education Canada Inc.