Chapter 9 Growth

Chapter Objectives The significance of growth Production possibility frontier Growth versus the zero-sum economy Measuring growth What drives growth Productivity Government and growth

The Significance of Growth Growth in an economy simply means that it produces more goods and services than before. Economic growth is important because it results in a higher standard of living; thus people are better off. A second benefit of growth is that it gives us more choices, as the economy is able to produce more good and services.

Production Possibility Frontier The production possibility frontier (PPF) is defined as all the combinations of different goods and services that the economy is capable of producing at a particular time. A PPF graph for two outputs, healthcare and entertainment, is shown on the next slide. Economic growth allows the PPF to shift outward, meaning that the economy can now produce more healthcare, more entertainment, or both.

Production Possibility Frontier

Growth versus the Zero-Sum Economy A zero-sum economy is one of no growth. In this case, to increase the production of one good, we must cut the production of something else. With no growth, the economy operates on the same production possibility frontier. A growing economy is a non-zero-sum. In this case, the production possibility frontier is shifting outward. It is possible to get more of both goods.

Growth and the PPF x x B A Entertainment (more ) Healthcare (more ) Production possibility frontier next year Production possibility frontier today Healthcare (more )

Growth versus the Zero-Sum Economy The growth versus zero-sum argument can be applied to the distribution of income. With no growth, the only way to make low-income households better off is to take money away from middle-income or high-income households. In a growing economy, it is possible for everyone to see their incomes rise.

Measuring Growth GDP is a good indicator of growth in the economy. But we must distinguish between nominal and real GDP. Nominal GDP measures the output of an economy in dollars, not accounting for inflation. Growth of nominal GDP includes both economic growth and the effect of inflation.

Real GDP The Bureau of Economic Analysis (BEA) adjusts GDP for inflation using its estimate of the average price level in the economy. The resulting number is called real GDP. Thus, economic growth, or real GDP growth, is equal to the growth in nominal GDP adjusted for inflation.

Economic Growth, 1950-2007

Increase in Living Standards To determine how fast the standard of living is improving, we look at the change in GDP per capita. Real GDP per capita is real GDP divided by the number of people in the country. In other words, real GDP per capita is the amount of economic output each person would get if we split up the entire economy evenly and gave everyone a piece.

Calculating Real GDP Per Capita (billions of 2000 dollars) Population (millions) per capita 2005 11,013 297.0 $37,100 2006 11,319 299.8 $37,800 Percentage change from 2005 to 2006 2.9% 1.0% 1.9%

Short-term versus Long-term Growth Short-term growth is growth on a year-to-year basis. Long-term growth looks at growth over longer periods. The chart on the next slide shows long-term growth in GDP per capita for US. This shows a steady climb in US living standards.

Real GDP per Capita

What Drives Growth Economic growth depends on the growth in inputs. The aggregate production function tells us what the output, or GDP, of the economy is, given the following inputs: Number of workers, education and skill of workers, equipment and structures, raw materials, and land and knowledge.

The Forces Driving Growth Increase in equipment and structures (physical capital) Increase in education and skill level (human capital) Increase in raw materials Increase in number of workers Increase in knowledge Aggregate production function Real GDP growth

Number of Workers and Human Capital As the labor force increases, output should rise as well. The labor force is defined as the number of people working or available for work. Besides the number of workers, their education and skill are critical for growth. Human capital is the skill level of the workforce. In general, better trained and more educated workers will produce more.

College Education and the Young

Investment in Physical Capital A firm’s purchase of equipment and buildings for production (physical capital) is essential for growth. Production of any good requires physical capital. Giving workers more and better equipment will enable them to produce more.

Increase in Raw Materials Raw materials are an essential input for growth. Raw materials include everything from oil to bauxite to water. Economies consume more raw materials as they grow. Greater use of raw materials has potentially negative environmental consequences.

Increase in Knowledge Increases in knowledge are probably the main source of growth in the developed countries such as the US. Better knowledge leads to new products and new methods of production. We can produce more goods and services with the same amount of resources. Increases in knowledge include improvements in science and technology.

Productivity The productivity of an economy is real GDP for a given year divided by the total number of hours worked in that year by all workers. Higher productivity means that the economy can produce more output with the same number of workers. The growth rate of productivity is the percentage increase in productivity over a year. High productivity growth means that workers can produce more goods and services and the company can pay higher wages.

History of US Productivity Growth 3.0% 2.5% 2.0% 1.5% Non-farm business productivity (average annual growth) 1.0% 0.5% 0.0% Golden Age 1947-1973 Productivity Slowdown 1973-1995 New Economy 1995-2007

Government and Growth The government plays a key role by setting the laws and rules under which business operates. Some laws and rules encourage growth by making markets work better. Other laws and rules may reduce growth. The extent of government intervention in the economy is subject to intense political debate.