Economic Growth and productivity Section 7

LONG-RUN ECONOMIC GROWTH Module 37 2

I. Comparing Economies across Time and Space M37: LONG-RUN ECONOMIC GROWTH I. Comparing Economies across Time and Space A. Real GDP per Capita B. Growth Rates II. The Sources of Long-Run Growth A. The Crucial Importance of Productivity B. Explaining Growth in Productivity 1. Physical Capital 2. Human Capital 3. Technology What we will cover

Real GDP per capita is real GDP divided by the total population. Standard of living (or quality of life) can be measured, in part, by how well the economy is doing… But it needs to be adjusted to reflect the size of the nation’s population. Real GDP per capita is real GDP divided by the total population. Total Slice of the pie: GDP measures total value of an economy’s production & income earned. Size of the pie adjusted after inflation: Real GDP separates changes in Q of good & services from rising inflation This gives us the size of each person’s slice of the pie, if it were shared equally. Real GDP per capita because we want to isolate the effect of changes in the population. Real GDP per capita is the best measure of a nation’s standard of living. GDP because, as we have learned, GDP measures the total value of an economy’s production of final goods and services as well as the income earned in that economy in a given year. Think of this as the total size of the economic pie. • Real GDP because we want to separate changes in the quantity of goods and services from the effects of a rising price level. This is the size of the pie after adjusting for inflation. • Real GDP per capita because we want to isolate the effect of changes in the population. This gives us the size of each person’s slice of the pie, if it were shared equally.

There are some problems with using GDP to measure a nation’s true standard of living 5

The top 5 most populated countries

GDP Per Capita: real GDP divided by the population size. -there are now more people to share a given amount of real GDP. An increase in real GDP that only matches an increase in population leaves the average standard of living unchanged. *An increase in the population lowers the standard of living for the average person

Growth Rates Growth rates are like compounded interest.   If the annual interest rate is 10% at the bank, and you are saving $100, after year 1 you will have $110, an increase of $10. After year two, you will have $121, an additional increase of $11. If the economy grows by 2% one year, and another 2% the following year, and another 2% the year after that, these annual growth rates are compounded into larger and larger increases in per capital real GDP. Rule of 70 approximates how many years it will take for the economy to double at a given rate of economic growth. # of years for a number to double = (70/annual growth rate of that number) Ex. If annual per capita real GDP increases at 5% every year, it will take approximately 14 years for it to double. The million dollar question is why some nations have faster long-run economic growth than others.

Rule of 70: Growth Rates Growth rates are like compounded interest The addition of interest to the principal sum of a loan. EX: If the annual interest rate is 10% at the bank, and you are saving $100, after year 1 you will have $110, an increase of $10. After year two, you will have $121, an additional increase of $11.   If the economy grows by 2% one year, and another 2% the following year, and another 2% the year after that, these annual growth rates are compounded into larger and larger increases in per capital real GDP. Rule of 70 approximates how many years it will take for the economy to double at a given rate of economic growth. # of years for a number to double = (70/annual growth rate of that number) Ex. If annual per capita real GDP increases at 5% every year, it will take approximately 14 years for it to double. The million dollar question is why some nations have faster long-run economic growth than others. Rule of 70: How many years it will take for the economy to double at a given rate of economic growth. # of years for a number to double = (70/annual growth rate) Ex. If annual per capita real GDP increases at 5% every year, it will take approximately 14 years for it to double.

The Sources of Long-Run Growth Physical Capital (Machinery) Human Capital (Education) Technology (new methods of production) Why some nations have faster long-run economic growth than others. PRODUCTIVITY

The Crucial Importance of Productivity Sustained growth in real GDP per capita occurs only when the amount of output produced by the average worker increases steadily. Labor productivity (output per worker) = (real GDP/# of people working) If workers are creating more output, on average, the size of the economic pie will be rising and the average person’s slice will also be rising. What factors lead to higher productivity? Physical Capital Human Capital Technology

Sample Problem Real per capita GDP is: A) real GDP divided by the population B) real GDP divided by the amount of capital available in the economy C) not a good useful measure of human welfare D) the depth of the ocean floor for sea monsters E) measures the value of the nation’s financial markets

Sample Problem Real per capita GDP is: A) real GDP divided by the population B) real GDP divided by the amount of capital available in the economy C) not a good useful measure of human welfare D) the depth of the ocean floor for sea monsters E) measures the value of the nation’s financial markets

Sample Problem The key statistic to measure economic growth is: A) the size of the government’s budget B) real GDP per capita C) life expectancy D) the Dow Jones stock market index E) the size of the national debt

Sample Problem The key statistic to measure economic growth is: A) the size of the government’s budget B) real GDP per capita C) life expectancy D) the Dow Jones stock market index E) the size of the national debt

Sample Problem If a country has a population of 1,000 an area of 100 square miles, and a GDP of $5,000,000, then its GDP per capita is: A) $500 B) $5,000 C) $50,000 D) 5,000,000 E) $50

Sample Problem If a country has a population of 1,000 an area of 100 square miles, and a GDP of $5,000,000, then its GDP per capita is: A) $500 B) $5,000 C) $50,000 D) 5,000,000 E) $50

Sample Problem The rule of 70 indicates that a 6% annual increase in the potential level of real GDP would lead to the potential output doubling in about _____years. A) 6 B) 12 C) 24 D) 30 E) 35

Sample Problem The rule of 70 indicates that a 6% annual increase in the potential level of real GDP would lead to the potential output doubling in about _____years. A) 6 B) 12 C) 24 D) 30 E) 35

Sample Problem If real GDP doubles in 35 years, its average annual growth rate is approximately______? A) 1% B) 2% C) 3% D) 4% E) 7%

Sample Problem If real GDP doubles in 35 years, its average annual growth rate is approximately______? A) 1% B) 2% C) 3% D) 4% E) 7%

Sample Problem The Rule of 70 applies: A) only to GDP B) only to GDP per capita C) to any growth rate D) only to developed countries E) only in games of horseshoes

Sample Problem The Rule of 70 applies: A) only to GDP B) only to GDP per capita C) to any growth rate D) only to developed countries E) only in games of horseshoes

PRODUCTIVITY AND GROWTH Module 38

I. Productivity and Growth M38: Productivity and Growth I. Productivity and Growth A. Accounting for Growth: The Aggregate Production Function B. What About Natural Resources? II. Success, Disappointment, and Failure A. East Asia’s Miracle B. Latin America’s Disappointment C. Africa’s Troubles What we will cover

Accounting for Growth: The Aggregate Production Function Productivity ⬆︎ : ⬆ physical capital, more human capital, better technology, Aggregate Production Function: shows how productivity depends on the quantities of physical capital per worker and human capital per worker as well as the state of technology   

Accounting for Growth: The Aggregate Production Function Diminishing Returns to Physical Capital: all else equal, as physical capital is increased, aggregate output increases by a smaller amount. Office Typist are given better computers:    Growth Accounting: estimates the contribution of each major factor in the aggregate production function. Total Factor Productivity: amount that can be achieved with a given amount of factor inputs

PHYSICAL CAPITAL AND PRODUCTIVITY Diminishing Returns to Physical Capital

TECHNOLOGICAL PROGRESS AND PRODUCTIVITY GROWTH

What About Natural Resources? Other things equal, more natural resources leads to higher GDP per capita Other things are often NOT equal (Political / Legal instability) Malthus: “ An Essay on the principle of Population” As population grew, the amount of land per worker would decline. Other things being equal, productivity would fall. Increase Tech or physical capital would only lead to temporary improvements.  

Success, Disappointment, and Failure East Asia’s Miracle convergence hypothesis Latin America’s Disappointment Africa’s Troubles LATIN AMERICA Since about 1920, growth in Latin America has been disappointing. The fact that South Korea is now much richer than Argentina would have seemed inconceivable a few generations ago. Why has Latin America stagnated? Comparisons with East Asian success stories suggest several factors. • The rates of savings and investment spending in Latin America have been much lower than in East Asia, partly as a result of irresponsible government policy that has eroded savings through high inflation, bank failures, and other disruptions. • Education—especially broad basic education—has been underemphasized: even Latin American nations rich in natural resources often failed to channel that wealth into their educational systems. • And political instability, leading to irresponsible economic policies, has taken a toll. AFRICA Real GDP per capita in sub-Saharan Africa actually fell 13 percent from 1980 to 1994, although it has recovered since then. The consequence of this poor growth performance has been intense and continuing poverty. What explains it? Several factors are probably crucial. • Perhaps first and foremost is the problem of political instability. In the years since 1975, large parts of Africa have experienced savage civil wars (often with outside powers backing rival sides) that have killed millions of people and made productive investment spending impossible. • The threat of war and general anarchy has also inhibited other important preconditions for growth, such as education and provision of necessary infrastructure. • Property rights are also a problem. The lack of legal safeguards means that property owners are often subject to extortion because of government corruption, making them averse to owning property or improving it. This is especially damaging in a country that is very poor.

Are Economies Converging?

Sample Problem In the long run an increase in saving will generally: A) reduce the rate of economic growth B) leave the rate of economic growth unchanged C) increase the rate of economic growth D) increase consumption simultaneously E) decrease the standard of living

Sample Problem In the long run an increase in saving will generally: A) reduce the rate of economic growth B) leave the rate of economic growth unchanged C) increase the rate of economic growth D) increase consumption simultaneously E) decrease the standard of living

Sample Problem Which of the following will NOT increase the productivity of labor? A) technological improvements B) an increase in the capital stock C) improvements in education D) an increase in the size of the labor force E) a lower literacy rate

Sample Problem Which of the following will NOT increase the productivity of labor? A) technological improvements B) an increase in the capital stock C) improvements in education D) an increase in the size of the labor force E) a lower literacy rate

Sample Problem Investment in human capital shifts the aggregate production function: A) downward B) leftward C) inward D) rightward E) upward

Sample Problem Investment in human capital shifts the aggregate production function: A) downward B) leftward C) inward D) rightward E) upward

Sample Problem Physical capital would include: A) the education or knowledge a worker has in his or her physical being B) the tools a worker has to work with C) the money available for the worker to use D) the stocks and bonds in an individual’s portfolio E) the natural resources a worker has to work with

Sample Problem Physical capital would include: A) the education or knowledge a worker has in his or her physical being B) the tools a worker has to work with C) the money available for the worker to use D) the stocks and bonds in an individual’s portfolio E) the natural resources a worker has to work with

Module 39: Economic Growth Policy Investment Spending leads to an increase in physical capital Investment Spending comes from domestic savings or inflows of foreign capital Business R&D is a key to increasing physical capital

The Role of Government in Promoting Economic Growth Governments and Physical Capital infrastructure Governments and Human Capital Governments and Technology Political Stability, Property Rights and Excessive Intervention   1. Governments and Physical Capital Governments provide infrastructure by building roads, airports, seaports, electrical grids and many others. These systems help consumers and firms engage in economic activity that promotes economic growth. Private firms also invest in physical capital like building new factories, shopping malls, and housing developments. Firms also purchase computer systems, delivery trucks, forklifts and many other pieces of physical capital. If the government can provide infrastructure and maintain a financial system that provides for the saving and borrowing that is required for private investment, a nation’s physical capital will grow. 2. Governments and Human Capital Governments pay for the vast share of primary and secondary education. Any American child can complete high school at very little out-of-pocket expense. When nations make education a higher priority, they subsidize it. More people acquire the education and the nation prospers with long-run economic growth. 3. Governments and Technology While much R & D is done by private companies, the government subsidizes this research with grants. The government also provides direct support and grant money to professors at public and private universities and that research helps to drive technological progress. 4. Political Stability, Property Rights, and Excessive Government Intervention Suppose a firm wants to build a factory that produces gadgets in a foreign nation Kreblakistan. Firms are going to be very hesitant to invest in Kreblakistan if the government might be radically overthrown, or if the government could just claim the factory as government property. Or maybe Kreblakistan’s courts and government bureaucracies are corrupt so that day-to-day business transactions require bribes or hush money. Firms are not going to want to invest in nations such as this. At the other extreme, a nation’s government could excessively intervene in markets with high taxes, tariffs, or other anti-competitive policies. This can also slow down economic growth. 43

AN EXAMPLE OF HOW INVESTMENT IN HUMAN CAPITAL CAN LEAD TO INCREASED GROWTH AND A HIGHER GDP PER CAPITA 44

THE REAL PRICE OF OIL IS BASED ON DEMAND AND NOT IMPORTATION ISSUE: (SEE THE NEXT SLIDE) 45

AS THE ECONOMY GROWS CONSUMPTION (DEMAND) GROWS WITH IT AND THIS, NOT IMPORTATION ISSUES, ARE THE CAUSE OF HIGHER PRICES AT THE GAS PUMP TODAY 46

THE ISSUE OF GROWTH AND ENVIORNMENTAL DAMAGE IS A WORLD-WIDE ISSUE AND NOT A UNITED STATES ISSUE ALONE 47

ENVIORNMENTAL CONCERNS Pollution is a negative externality because it allows firms to impose a cost on society without having to pay compensation Many have called for “cap and trade” policies which impose costs and limits/purchases/trades on firms who are engaged in pollution type industries.

ECONOMIC GROWTH IN MACROECONOMIC MODELS Module 40

Long-run Economic Growth and the Production Possibilities Curve (PPC) M40: ECONOMIC GROWTH IN MACROECONOMIC MODELS Long-run Economic Growth and the Production Possibilities Curve (PPC) Long-run Economic Growth and the Aggregate Demand and Supply Model Distinguishing Between Long-run Growth and Short-run Fluctuations What we will cover

Long-run Economic Growth and the PPC LONG-RUN ECONOMIC GROWTH IS BASED UPON THE SUSTAINED RISE IN THE PRODUCTION OF GOODS AND SERVICES SHORT-RUN “UPS” AND “DOWNS” ARE THE RESULT OF THE BUSINESS CYCLE

Long-run Economic Growth and the Production Possibilities Curve EXAMPLE: Two nations: nation X and nation Y same PPC in 2010 Suppose: nation X chooses a point like A: where most of the resources are used to produce consumption goods. Nation Y chooses a point like B, where most of the resources are used to produce investment goods. Both nations will experience growth in the PPC, but Nation Y experiences more growth over time because investments in physical capital goods produce other goods. In fact, if a nation like Nation X focuses solely on consumption goods, their current stock of physical capital will begin to depreciate. Machinery used to produce other goods eventually wears out and becomes useless. If this were to happen the PPC could even shift inward. Consumption goods: Food, clothing, entertaining Investment goods: Physical Capital Where will these PPC’s lie in 20 years? 52

Bowed out shape reflects increasing opportunity cost Remember this? Bowed out shape reflects increasing opportunity cost Economic growth shows as an outward shift The Economy can produce more of everything 53

Actual and Potential Output from 1989 to 2009 54

Long-run Growth vs Short-run Fluctuations Long-run economic growth is the sustained rise in the quantity of goods and services the economy can produce. In the AD/AS model, a short-run fluctuation of the business cycle would be seen as a shift of the AD curve or SRAS curve. For example, a recessionary gap may result in a decrease in input prices and an increase in SRAS, but that does not mean the same thing as economic growth. Likewise, an inflationary gap results not in growth, but in a return of the economy to it’s long run equilibrium.

You must distinguish between long-run growth and short-run business cycle (SRAS) Is there efficient use of the economy’s resources? New potential output 56

D A 57

From the Short Run to the Long Run: Notice the impact of wages on SRAS since wages are an input 58