Ch 17 Economic Growth and Ch 22 International Trade

Economic Growth Until Ch. 15 we assumed LRAS is fixed at the Natural Real GDP. In this chapter we look at factors that shift the LRAS and hence results in economic growth. Economic Growth: An increase in Real GDP (total quantity of goods and services) from one period to the next.

Factors affecting Real GDP The total output (Real GDP) depends upon the inputs and technology (knowledge about the use of inputs). Hence, we say Real GDP is a function of technology (T), labor (L) and capital (C). This is called a production function. E.g. Real GDP = T (L + K) If, T = 0.4, L = 5, K = 5, Then, Real GDP = 0.4 (5 +5) = 4 units of output

Real GDP will increase if there is an increase in inputs (labor, capital etc) and/or improvement in the state of technology. If technology improves then value of T would increase and we would obtain more output using the given resources. If Real GDP increases, then economic growth occurs and LRAS shifts right.

Human Capital Another possible way to increase Real GDP and hence bring about economic growth is by improving the human capital of an economy. Human Capital: The knowledge and skills a person acquires through education, training and experience. If human capital improves we will be able to obtain more output using the same amount of labor. Similar to improvement in technology.

International Trade International Trade between economies may lead to economic growth as well. This is illustrated using the example in the next slide. Initially, no-specialization-no-trade: US produces 60 units of food and 10 units of cloth and Japan produces 10 units of food and 5 units of cloth. Then, the countries decide to specialize and trade. Which country specializes in what?

According to economic theory a country should specialize in that product which it can produce at a lower opportunity cost (O.C) as compared to another country. E.g. For US the O.C of 90 units of food is 30 units of cloth. Hence, the O.C of 1 unit of food is (1 ÷ 3) units of cloth. For Japan the O.C of 15 units of food is 15 units of cloth. Hence, the O.C. of 1 unit of food is 1 unit of cloth. Conclusion: US can make cloth at a lower O.C. than Japan. So US should specialize in cloth (C).

Similarly, we can find Japan can make food at a lower O Similarly, we can find Japan can make food at a lower O.C as compared to U.S. Hence Japan specializes in food (F). Now, U.S and Japan has to decide on the terms of trade. It is given as: 2 F = 1 C i.e. U.S. will give Japan 2 units of food and Japan in return will give 1 unit of cloth. Keeping this info in mind we look at the table next slide. The result: U.S. has more food after specialization and trade and Japan has more clothes. More output for both countries i.e. economic growth!

Trade Restrictions Even though international trade can be beneficial for countries. Most countries have trade restrictions – which restrict international trade. Tariff: A tax on imports. Increases price of imported goods. Why? Government revenue and protection of domestic industries and jobs

Quota: A legal limit imposed on the amount of a good that may be imported. A quota reduces the supply of a good and raises the price of imported goods for domestic consumers. Again, this can be used to protect local businesses and jobs.