1 of 20 © 2012 Pearson Education, Inc. Publishing as Prentice Hall PART IV Further Macroeconomics Issues Prepared by: Fernando Quijano & Shelly Tefft CASE FAIR OSTER P R I N C I P L E S O F MACROECONOMICS T E N T H E D I T I O N

2 of 20 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc. Publishing as Prentice Hall

3 of 20 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc. Publishing as Prentice Hall CHAPTER OUTLINE 17 Long-Run Growth The Growth Process: From Agriculture to Industry Sources of Economic Growth Increase in Labor Supply Increase in Physical Capital Increase in the Quality of the Labor Supply (Human Capital) Increase in the Quality of Capital (Embodied Technical Change) Disembodied Technical Change More on Technical Change U.S. Labor Productivity: 1952 I–2010 I Growth and the Environment and Issues of Sustainability

4 of 20 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc. Publishing as Prentice Hall output growth The growth rate of the output of the entire economy. per-capita output growth The growth rate of output per person in the economy. labor productivity growth The growth rate of output per worker.

5 of 20 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc. Publishing as Prentice Hall The production possibility frontier shows all the combinations of output that can be produced if all society’s scarce resources are fully and efficiently employed. Economic growth expands society’s production possibilities, shifting the ppf up and to the right.  FIGURE 17.1 Economic Growth Shifts Society’s Production Possibility Frontier Up and To the Right The Growth Process: From Agriculture to Industry

6 of 20 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc. Publishing as Prentice Hall Beginning in England around 1750, technical change and capital accumulation increased productivity significantly in two important industries: agriculture and textiles. New inventions and new machinery meant that more could be produced with fewer resources. Growth meant new products, more output, and wider choice. A rural agrarian society was quickly transformed into an urban industrial society. Economic growth continues today in the developed world, and while the underlying process is still the same, the face is different. Growth comes from a bigger workforce and more productive workers. Higher productivity comes from tools (physical capital); a better-educated and more highly skilled workforce (human capital); and increasingly from innovation, technical change, and newly developed products and services. The Growth Process: From Agriculture to Industry

7 of 20 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc. Publishing as Prentice Hall TABLE 17.1 Growth of Real GDP: 1991–2007 Country Average Growth Rates per Year, percentage points, United States3.0 Japan1.3 Germany1.7 France1.9 United Kingdom2.5 China10.4 India6.3 Africa3.8 The Growth Process: From Agriculture to Industry catch-up The theory stating that the growth rates of less developed countries will exceed the growth rates of developed countries, allowing the less developed countries to catch up. This idea that gaps in national incomes tend to close over time is called convergence theory. An economic historian coined the term the advantages of backwardness over 50 years ago to describe the phenomenon of less developed countries leaping ahead by borrowing technology from more developed countries.

8 of 20 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc. Publishing as Prentice Hall aggregate production function A mathematical relationship stating that total GDP (output) depends on the total amount of labor used and the total amount of capital used. Sources of Economic Growth The numbers that are used in Tables 17.2 and 17.4 that follow are based on the simple production function Y = 3 × K 1/3 L 2/3. Both capital and labor are needed for production and increases in either result in more output. Using this construct we can now explore exactly how an economy achieves higher output levels over time as it experiences changes in labor and capital.

9 of 20 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc. Publishing as Prentice Hall TABLE 17.2 Economic Growth from an Increase in Labor—More Output but Diminishing Returns and Lower Labor Productivity Period Quantity of Labor L Quantity of Capital K Total Output Y Labor Productivity Y/L Sources of Economic Growth Increase in Labor Supply

10 of 20 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc. Publishing as Prentice Hall TABLE 17.3 Employment, Labor Force, and Population Growth, 1960–2008 Civilian Noninstitutional Population 16 and Over (Millions) Civilian Labor Force Employment (Millions) Number (Millions) Percentage of Population Percentage change, 1960– %+126.7%+121.0% Annual rate+1.4%+1.6%+1.6% Sources of Economic Growth Increase in Labor Supply

11 of 20 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc. Publishing as Prentice Hall TABLE 17.4 Economic Growth from an Increase in Capital—More Output, Diminishing Returns to Added Capital, Higher Labor Productivity Period Quantity of Labor L Quantity of Capital K Total Output Y Labor Productivity Y/L Output per Capital Y/K Sources of Economic Growth Increase in Physical Capital

12 of 20 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc. Publishing as Prentice Hall TABLE 17.5 Fixed Private Nonresidential Net Capital Stock, 1960–2008 (Billions of 2005 Dollars) EquipmentStructures , ,146.83, ,919.65, ,603.86, ,204.18, ,400.09,266.5 Percentage change, 1960– %+224.0% Annual rate+4.4%+ 2.4% Sources of Economic Growth Increase in Physical Capital foreign direct investment (FDI) Investment in enterprises made in a country by residents outside that country.

13 of 20 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc. Publishing as Prentice Hall TABLE 17.6 Years of School Completed by People Over 25 Years Old, 1940–2008 Percentage with Less than 5 Years of School Percentage with 4 Years of High School or More Percentage with 4 Years of College or More NA NA NA NA = not available. Sources of Economic Growth Increase in the Quality of the Labor Supply (Human Capital)

14 of 20 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc. Publishing as Prentice Hall In discussions of using education and health care to boost labor productivity, the context is often the developing economies, where the overall level of health and education are low. Developed economies like the United Kingdom are also concerned about the skill level of their labor force as they contemplate their productivity and growth rates. Education and Skills in the United Kingdom E C O N O M I C S I N P R A C T I C E U.K. Businesses Press for Focus on Skills The Wall Street Journal

15 of 20 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc. Publishing as Prentice Hall Sources of Economic Growth Increase in the Quality of Capital (Embodied Technical Change) embodied technical change Technical change that results in an improvement in the quality of capital. Disembodied Technical Change disembodied technical change Technical change that results in a change in the production process. invention An advance in knowledge. innovation The use of new knowledge to produce a new product or to produce an existing product more efficiently. More on Technical Change

16 of 20 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc. Publishing as Prentice Hall  FIGURE 17.2 Output per Worker Hour (Productivity), 1952 I–2010 I Sources of Economic Growth U.S. Labor Productivity: 1952 I–2010 I

17 of 20 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc. Publishing as Prentice Hall TABLE 17.7 Environmental Scores in the World Bank Country Policy and Institutional Assessment 2005 Scores (min = 1, max = 6) Albania3 Angola2.5 Bhutan4.5 Cambodia2.5 Cameroon4 Gambia3 Haiti2.5 Madagascar4 Mozambique3 Papua New Guinea1.5 Sierra Leone2.5 Sudan2.5 Tajikistan2.5 Uganda4 Vietnam3.5 Zimbabwe2.5 Growth and the Environment and Issues of Sustainability

18 of 20 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc. Publishing as Prentice Hall One measure of air pollution is smoke in cities. The relationship between smoke concentration and per-capita GDP is an inverted U: As countries grow wealthier, smoke increases and then declines.  FIGURE 17.3 The Relationship Between Per-Capita GDP and Urban Air Pollution Growth and the Environment and Issues of Sustainability

19 of 20 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc. Publishing as Prentice Hall Much of Southeast Asia has fueled its growth through export-led manufacturing. For countries that have based their growth on resource extraction, there is another set of potential sustainability issues. Because extraction can be accomplished without a well-educated labor force, while other forms of development are more dependent on a skilled-labor base, public investment in infrastructure is especially important. Growth and the Environment and Issues of Sustainability

20 of 20 PART IV Further Macroeconomics Issues © 2012 Pearson Education, Inc. Publishing as Prentice Hall aggregate production function catch-up disembodied technical change embodied technical change foreign direct investment (FDI) innovation invention labor productivity growth output growth per-capita output growth R E V I E W T E R M S A N D C O N C E P T S