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25 Economic Growth CHECKPOINTS 2

Checkpoint 25.1 Checkpoint 25.3 Checkpoint 25.4 Checkpoint 25.2 Problem 1 Problem 1 Problem 1 Clicker version Problem 2 Problem 2 Clicker version Problem 2 Clicker version Problem 3 In the news Problem 3 Clicker version In the news Problem 4 Clicker version Checkpoint 25.2 Problem 5 Problem 1 In the news Problem 2 In the news

Practice Problem 1 CHECKPOINT 25.1 Mexico’s real GDP was 8,762 billion pesos in 2010 and 9,105 billion pesos in 2011. Mexico’s population growth rate in 2011 was 1 percent. Calculate Mexico’s economic growth rate in 2011 and the growth rate of real GDP per person in Mexico in 2011. 4

CHECKPOINT 25.1 Solution The economic growth rate equals the percentage change in real GDP: [(Real GDP in 2011 – Real GDP in 2010) ÷ Real GDP in 2010] x 100. When we substitute the numbers, Mexico’s economic growth rate equals [(9,105 billion – 8,762 billion) ÷ 8,762] x 100. Mexico’s economic growth rate in 2011 was 3.9 percent. 5

CHECKPOINT 25.1 Growth rate of real GDP per person equals the growth rate of real GDP minus the population growth rate. When we substitute the numbers, Growth rate of real GDP per person = (3.9 – 1) percent, which is 2.9 percent. The growth rate of real GDP per person in Mexico in 2011 was 2.9 percent. 6

Practice Problem 2 CHECKPOINT 25.1 Calculate the approximate number of years it will take for real GDP per person to double if an economy maintains an economic growth rate of 12 percent a year and a population growth rate of 2 percent a year. 7

CHECKPOINT 25.1 Solution The growth rate of real GDP per person equals the economic growth rate minus the population growth rate. Real GDP per person grows at (12 – 2) percent a year, which is 10 percent a year. The Rule of 70 tells us that the level of a variable that grows at 10 percent a year will double in 70 ÷ 10 years, or 7 years, if the growth rates are maintained. It will take 7 years for real GDP per person to double. 8

Practice Problem 3 CHECKPOINT 25.1 Calculate the change in the number of years it will take for real GDP per person in India to double if real GDP per person increases from 8 percent a year to 10 percent a year. 9

CHECKPOINT 25.1 Solution The Rule of 70 tells us that a variable that grows at 8 percent a year will double in 70 ÷ 8 years, which is approximately 9 years. By increasing its growth rate to 10 percent a year, the variable will double in 7 years. Real GDP per person in India will two years earlier. 10

In the news CHECKPOINT 25.1 ADB reduces China’s growth estimate Since 1980, China’s real GDP per person has grown at 10 percent per year. The Asian Development Bank (ADB) cut its estimate for China’s growth to 9.3 percent this year. Source: Bloomberg, September 13, 2011 If China’s growth rate remains at 9.3 percent a year, how many additional years will it take for China to double its real GDP per person? 11

CHECKPOINT 25.1 Solution With a growth rate of 10 percent a year, real GDP per person will double in 7 years (70 ÷ 10), If the growth rate is maintained at 9.3 percent a year, real GDP per person will double in 7.5 years (70 ÷ 9.3). It will take an additional 0.5 years for real GDP per person to double. 12

Practice Problem 1 CHECKPOINT 25.2 The table provides some data for an economy in 2009 and 2010. Calculate the growth rate of real GDP in 2010. 13

Solution CHECKPOINT 25.2 Growth rate of real GDP in 2010 equals (Real GDP in 2010 – Real GDP in 2009) ÷ Real GDP in 2009 x 100 = ($1,050 – $1,000) ÷ $1,000) x 100 = 5 percent. 14

Practice Problem 2 CHECKPOINT 25.2 The table provides some data for an economy in 2009 and 2010. Calculate the labor productivity in 2009 and 2010. Calculate the growth rate of labor productivity in 2010. 15

CHECKPOINT 25.2 Solution Labor productivity equals real GDP per hour of labor. In 2009, labor productivity = $1,000 ÷ 25 = $40.00 an hour. In 2010, labor productivity = $1,050 ÷ 25.6 = $41.02 an hour. Labor productivity growth rate = (41.02 – 40.00) ÷ 40.00 x 100 = 2.55 percent. 16

In the news CHECKPOINT 25.2 Labor productivity on the rise The BLS reported the following data for the year to June 2011: In the nonfarm sector, output increased by 2.4 percent as aggregate hours increased 1.6 percent; in the manufacturing sector, output increased 4.6 percent as aggregate hours increased by 2.1 percent. Source: bls.gov/news.release As aggregate hours increased, output increased, but did labor productivity in each sector increase? In which sector was growth in labor productivity greater? 17

CHECKPOINT 25.2 Solution Output = Aggregate hours × Labor productivity. In each sector, output increased by more than the increase in aggregate hours, so labor productivity must have increased. Output growth in the manufacturing sector was almost double that in the nonfarm sector while growth of aggregate hours was approximately the same, so labor productivity must have increased by a larger percentage in manufacturing than in the nonfarm sector. 18

Practice Problem 1 CHECKPOINT 25.3 What is the classical growth theory and why does it say that economic growth will eventually end? 19

CHECKPOINT 25.3 Solution The classical growth theory predicts that labor productivity growth is temporary: When labor productivity increases, real GDP per person increases and because it exceeds the real income needed to maintain life, a population explosion occurs. The population becomes so large that capital per worker and labor productivity decrease and real GDP per person returns to its subsistence level. 20

Practice Problem 2 CHECKPOINT 25.3 What is the driving force of economic growth according to new growth theory? Why does it predict that the economic growth will never end? 21

CHECKPOINT 25.3 Solution The driving force of economic growth according to new growth theory is a persistent incentive to innovate and an absence of diminishing returns. New growth theory predicts that economic growth will never end because our unlimited wants will lead us to make choices that will bring ever-greater productivity and perpetual economic growth. 22

MyEconLab clicker question Correct answer is D CHECKPOINT 25.3 Study Plan Problem What is the driving force of economic growth according to new growth theory? Advancements in medical research. The pursuit of leisure. Religion Productive activities that can be replicated with no diminishing returns. Foreign investment. MyEconLab clicker question Correct answer is D 23

In the news CHECKPOINT 25.3 The productivity watch Former Federal Reserve chairman Alan Greenspan attributes the growth of labor productivity to IT investments that boosted labor productivity, which boosted company profits, which led to more IT investments, and so on, leading to a nirvana of high growth. Source: Fortune Magazine, September 4, 2006 Which of the growth theories that you’ve studied in this chapter best corresponds to the explanation given by Mr. Greenspan? 24

CHECKPOINT 25.3 Solution Mr. Greenspan is describing the new growth theory. According to this theory, the endless pursuit of profit leads to innovations (IT innovations in the period described here) that increase labor productivity, shift the production function upward, increase the demand for labor, raise the real wage rate, and increase profit. The perpetual pursuit of profit will bring persistent economic growth. 25

Practice Problem 1 CHECKPOINT 25.4 What are the preconditions for economic growth? 26

CHECKPOINT 25.4 Solution The preconditions for economic growth are economic freedom, private property rights, and markets. Without these preconditions, people have little incentive to undertake the actions that lead to economic growth. 27

Study Plan Problem What are the preconditions for economic growth? CHECKPOINT 25.4 Study Plan Problem What are the preconditions for economic growth? Entrepreneurial spirit and low unemployment. A large standing army and small government. A small government and property rights. Low unemployment and a large standing army. Economic freedom, private property rights, and markets. MyEconLab clicker question Correct answer is E 28

Practice Problem 2 CHECKPOINT 25.4 Why does much of Africa experience slow economic growth? 29

CHECKPOINT 25.4 Solution Some African countries experience slow economic growth because they lack economic freedom, private property rights are not enforced, and markets do not function well. People in these countries have little incentive to specialize and trade or to accumulate both physical and human capital. 30

MyEconLab clicker question Correct answer is D CHECKPOINT 25.4 Study Plan Problem Why does much of Africa experience slow economic growth? It lacks motivation to grow. It lacks aid from developed countries. It lacks natural resources and labor. It lacks economic freedom, private property rights that are enforced, and markets that function well. It lacks UN assistance. MyEconLab clicker question Correct answer is D 31

Practice Problem 3 CHECKPOINT 25.4 Why is economic freedom crucial for achieving economic growth? 32

CHECKPOINT 25.4 Solution Economic freedom is crucial for achieving economic growth because economic freedom allows people to make choices and gives them the incentives to pursue growth-producing activities. 33

MyEconLab clicker question Correct answer is A CHECKPOINT 25.4 Study Plan Problem Why is economic freedom crucial for economic growth? It gives the incentive to save, invest, expand human capital, and discover and apply new technologies. It protects workers’ rights and prevents unfair firing. It upholds democracy, which is essential if an economy is to grow. Only good government can make the right investment decisions. It ensures that the majority of citizens make the most important decisions. MyEconLab clicker question Correct answer is A 34

Practice Problem 4 CHECKPOINT 25.4 What role do property rights play in encouraging economic growth? 35

CHECKPOINT 25.4 Solution Clearly defined property rights and a legal system to enforce them give people the incentives to work, save, invest, and accumulate human capital. 36

MyEconLab clicker question Correct answer is D CHECKPOINT 25.4 Study Plan Problem What role do property rights play in encouraging economic growth? They increase the penalty for theft. The give governments the power to acquire property in the public interest. They create more equality of income. They strengthen the incentive to work, save, invest, and accumulate human capital. They ensure that debts are always paid. MyEconLab clicker question Correct answer is D 37

Practice Problem 5 CHECKPOINT 25.4 Explain why, other things remaining the same, a country with a well-educated population has a faster economic growth rate than a country that has a poorly educated population. 38

CHECKPOINT 25.4 Solution A well-educated population has more skills and a greater labor productivity than a poorly educated population. A well-educated population can contribute to the research and development that create new technology. 39

Practice Problem 6 CHECKPOINT 25.4 India’s economy hits the wall Just six months ago, the Indian economy was growing rapidly; now growth has halted. India needs to spend $500 billion upgrading its infrastructure and education and health-care facilities. Agriculture remains unproductive; and reforms, like strengthening the legal system, have been ignored. Source: BusinessWeek, July 1, 2008 Explain how the measures reported in the news clip could lead to faster economic growth in India. 40

CHECKPOINT 25.4 Solution Investment in infrastructure and education and heath-care facilities would increase India’s stock of physical capital, which would increase labor productivity. Better education and heath care would increase human capital and again increase labor productivity. With better technology and more capital used on farms, productivity of farm workers would increase. Strengthening the legal system could better enforce property rights. These measure could lead to faster growth in labor productivity and faster growth in real GDP per person. 41