Extension Chapter 5 The economics of growth

Learning objectives Understand how growth is defined and why it is important. Discuss the causes or ingredients of growth. Describe the classical growth model and its implications. Analyse how labour productivity and, therefore, living standards can be raised. Develop a formal full-employment growth model.

Learning objectives (cont.) Describe and explain the growth record of Australia. Briefly survey growth policies. Review the debate over the desirability of growth as an economic goal. Examine whether continued economic growth is feasible.

Growth economics The area of economics concerned with analysing the patterns of long-term trends in an economy’s productive capacity and factors that influence these trends.

Economic growth Economic growth is defined and measured in two ways: Increase in real GDP over time (% p.a.) e.g. comparing regional economic power or influence Increase in real GDP per capita over time (% p.a.) e.g. comparing standards of living

Importance of growth Greater ability to face economic challenges Small changes in growth can dramatically affect a country’s economy. Increased opportunities Incomes, education, social welfare, environmental Lessens the burden of scarcity Allows economy to realise economic goals more fully.

Causes of growth Six strategic ingredients of growth Supply factors: physical ability of economy to grow Quantity and quality of natural resources Quantity and quality of human resources Supply or stock of capital goods Technology Aggregate demand factors The demand factor The efficiency factor

Determinants of real output

Supply factors Growth is attributed to the availability of more and better resources, including the stock of technological knowledge. Two ways to increase output: increase in inputs of resources increase in the quality or productivity of those inputs. Labour force productivity Labour productivity is the real output per worker per hour. Total output = worker hours  labour productivity

Demand factors A growing level of demand is required in order for the full-employment of an expanding supply of resources. Demand and supply factors are interrelated.

Allocative factor In order to achieve productive potential, a nation must: have full-employment of resources AND achieve full production from resources. Resources must be allocated to get the maximum amount of goods and services possible.

Production possibilities Recall the production possibilities curve: points on the curve represent maximum amounts of production points inside the curve represent a failure to achieve full employment and full production. Improvement in supply factors will shift the curve outwards. Economy will not necessarily operate on the curve unless demand is sufficient and allocative efficiency is realised.

Economic growth and the production possibilities curve Consumer goods Capital goods B A

Models of growth: the classical model The classical model emphasises the supply side of economic growth Determinants of the productive capacity of the economy Interaction of two important factors: law of diminishing returns population growth.

Law of diminishing returns As successive increments of one resource are added to a fixed resource, beyond some point, the resulting increases in total output will diminish in size. Disproportionate increases in resources e.g. large increases in labour, smaller increases in arable land

Population growth Optimum population Population which, given the economy’s natural resources and technology, will yield the greatest income per person. Population growth may be a mixed blessing. Malthus’s thesis: Given diminishing returns, persistent and substantial population growth will force and maintain the standard of living close to the subsistence level (in less developed countries). If population growth coincides with increases in labour productivity then rising standards of living will occur (in industrially advanced countries).

Aggregate expenditures and growth Expanding levels of demand needed to achieve full-employment GDP Investment can be: income creating capacity creating capital–output ratio.

Equilibrium GDP with a rise in NX C+G+I (billions of dollars) 45 o Gross domestic product ($ billions) 510 490 470 450 450 470 490 510 530 (C + I + G )1 Full employment (Year 1) (C + I + G )2 Full employment (Year 2)

Full-employment growth model Emphasises: the capacity-creating characteristics of net investment while accounting for income-creating aspects role of saving role of the capital-output ratio.

Full-employment growth model (cont.) Capital–output ratio is the: relationship between net increases in the size and value of the capital stock (net investment) and sustainable increases in real GDP (capacity output). For example, ratio of 4:1 means for every $4 of net investment in year 1 the economy is capable of producing $1 of additional output in year 2 and succeeding years.

Full-employment growth model (cont.) The full-employment growth model demonstrates that: the economy’s full-employment growth rate can be calculated by dividing the average propensity to save (APS) by the capital–output ratio the APS and the growth rate are directly related the capital–output ratio and the growth rate are inversely related.

Australia’s growth record In the past 50 years: real GDP increased by 5.7 times real GDP per capita increased by 2.6 times over the period. Substantial improvements in product quality and leisure time have been made. Growth has been less than in many other developed nations.

Sources of Australian growth Labour inputs Population growth Immigration Productivity increases Technological progress Stock of capital Education and training Allocative efficiency and growth Other factors Political stability Social philosophy

Population and labour force growth in Australia, 1870–2009

Sources of population growth, 1949–50 to 2008–09

Growth policies Growth policies represent purposeful actions on the government’s part to enhance the prospects of growth. Policy depends on the school of thought, such as: Keynesian policies stress low interest rates to stimulate I and outline role of government supply-side policies emphasise tax cuts to enhance S & I, work effort and entrepreneurial activity new-classical economics advocate minimum government intervention.

The case against growth Pollution and environmental deterioration Problem resolution Does growth mean that poverty is eliminated? Human obsolescence and insecurity Increased insecurity as machines replace humans Growth and human values

In defence of growth Improved living standards Environmental benefits Control pollution not growth Growth as a vehicle for reducing income inequality Growth is more consistent with ‘the good life’ than is stagnation.

Are there limits to growth? Club of Rome and the Doomsday models state that: the growth paths of population, output and pollution are on a catastrophic collision course with production limits imposed by natural resources and the pollution-absorbing capacity of the environment.

Doomsday models Criticisms of the Doomsday models are: they incorrectly assume fixity of natural resources ignore the role of the price system and changing behavioural patterns underestimate role of technology underplay the impact of applying existing knowledge underplay the impact of new resources and products underestimate increasing returns to technology.

Next chapter Extension Chapter 6 The development of macroeconomic debates