Growth and Productivity: Long-Run Possibilities Chapter 17 Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

17-2 Growth and Productivity Rising living standards aren’t inevitable –How important is economic growth? –How does an economy grow? –Is continued economic growth possible? Is it desirable?

17-3 The Nature of Growth There are two ways in which output increases –Short-run changes in capacity utilization involve increased use of existing productive resources, moving us closer to the economy’s production possibilities curve –Long-run changes in capacity involve expansion of productive capacity - a shifting out of the PPC

17-4 Consumption Goods Investment Goods Consumption Goods Investment Goods 00 Two Types of Growth A B THE SHORT RUN: increased capacity utilization B A C THE LONG RUN: expanded capacity

17-5 Real Output Price Level Shifts in Long-Run Supply AD 2 LRAS 2 AD 1 LRAS 1 AS E1E1 E2E2 E3E3 To achieve economic growth, the long-run aggregate supply curve must shift to the right.

17-6 Nominal vs. Real GDP Economic growth is referred to in terms of real GDP, not nominal GDP –Real GDP: The value of final output produced in a given period, adjusted for changing prices By using base period prices, growth is measured in real goods and services, not inflation distorted dollars

17-7 Measures of Growth Changes in real GDP are presented as a growth rate Growth rate: Percentage change in real output from one period to another –Calculated as the change in real output between two periods divided by total output in the first period

17-8 Recent U.S. Growth Rates Source: Economic Report of the President, 2009

17-9 GDP per Capita: A Measure of Living Standards Growth in GDP per capita is attained only when the growth of output exceeds population growth

17-10 GDP per Worker: A Measure of Productivity GDP per capita rises when the labor force grows faster than the population –Labor Force: All persons over age 16 who are either working for pay or actively seeking paid employment –Employment rate: The percentage of the adult population that is employed

17-11 A Rising Employment Rate

17-12 GDP per Worker: A Measure of Productivity The employment rate cannot rise forever Increases in GDP per capita can also come from increases in output per worker Productivity: Output per unit of input

17-13 The Productivity Turnabout For economic growth to continue, the productivity of the average U.S. worker must rise still further Productivity slowdowns constrain GDP growth –From 1973 to 1995 productivity grew at an average rate of 1.4 percent –Jumping to 2.6 percent, productivity grew more rapidly after 1995

17-14 Productivity Gains Source: U.S. Department of Commerce

17-15 Sources of Growth Future growth depends on two factors: –Growth rate of the labor force –Growth rate of productivity

17-16 Sources of Growth Sources of productivity gains include: –Higher skills - an increase in labor skills –More capital - an increase in the ratio of capital to labor –Technological advances - development and use of better capital equipment and products –Improved management - better use of available resources in the production process

17-17 Human-Capital Investment Education and skills training have greatly increased the quality of U.S. labor The gains in productivity reflect greater human capital investment –Human capital is the knowledge and skills possessed by the labor force

17-18 Physical-Capital Investment A primary determinant of labor productivity is the rate of capital investment To increase productivity the quality and quantity of capital available to the average worker must continue to increase

17-19 U.S. Workers Compete Well U.S. productivity gains are among the fastest of industrial nations. These gains are fueled by research and development and investment spending. Source: U.S. Bureau of Labor Statistics

17-20 Saving and Investment Rates Savings are not just a form of leakage, but a basic source of investment financing There must be enough saving to at least finance net investment –Net investment: Gross investment less depreciation

17-21 Household and Business Saving Household saving rates in the U.S. have been notoriously low Virtually all U.S. investment has been financed with business saving and foreign investment Foreign investors have poured money into U.S. plant, equipment, software, and financial needs

17-22 Management Training Entrepreneurship and the quality of continuing management are major determinants of economic growth U.S. corporations spend billions of dollars on management training

17-23 Research and Development Research and development includes scientific research, product development, innovations in production techniques, and management improvements

17-24 New Growth Theory Old growth theory emphasized the importance of saving and investing in new plant and equipment New growth theory emphasizes the importance of investing in knowledge and ideas

17-25 Policy Tools Growth policy makes liberal use of the tools in the supply-side tool box –Increase human capital investment –Increase physical-capital investment –Maintain stable expectations –Pro-growth institutional framework

17-26 Increasing Human Capital Investment Governments invest in human-capital by building, operating, and subsidizing schools Immigration laws that promote immigration of skilled workers increase a nation’s stock of human capital

17-27 Increasing Physical Capital Investment The tax code stimulates investment through –Faster depreciation schedules –Tax credits for new investments –Lower business tax rates The government can also use the tax code to deepen the savings pool that finances investment

17-28 Infrastructure Development The government also directly affects the level of physical capital through its public works spending Public investments in infrastructure reduce transportation costs, increase market efficiency, and expand potential output

17-29 Fiscal Responsibility Short-run government policies may lead to a crowding out of consumer spending and investment Fiscal and monetary policies must be evaluated in terms of their impact not only on (short-run) aggregate demand but also on long-run aggregate supply

17-30 Maintaining Stable Expectations Expectations are a critical factor in both consumption and investment behavior A sense of political and economic stability is critical to any long-run current trends Macro policy must be sensitive to long-run expectations

17-31 Institutional Context Prospects for economic growth depend on the institutional context of a nation’s economy Greater economic freedom – secure property rights, open trade, lower taxes, less regulation – typically fosters faster growth

17-32 Limitless Growth? Could the economy keep growing forever? Wouldn’t we use up available resources and ruin the environment in the process? How much long-term growth is really possible or even desirable?

17-33 Limits to Food Production In 1798, Reverend Thomas Malthus predicted future starvation for England, believing population increases at a geometric rate while food supplies increase arithmetically Actual output – including agricultural products – has increased at a geometric rate, not at the much slower rate predicted by Malthus

17-34 Resource Constraints To keep growing, we need productivity improvements and resource availability All doomsday predictions ignore how markets promote efficient use of scarce resources and find substitutes for them

17-35 The Possibility and Desirability of Growth There are possibly no limits to growth Continued economic growth is desirable so long as –It brings a higher standard of living –It brings an increased ability to produce and consume socially desirable goods and services

Growth and Productivity: Long-Run Possibilities End of Chapter 17 Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin