Economic growth Chapter 8 4/23/2017 4/23/2017 1

Economic growth (8.1) Either: An increase in real GDP (or real GDP per capita) occurring over some time period [(Real GDP year 2-real GDP year 1)/real GDP year 1] x 100 Real GDP per capita = Real GDP/size of population 4/23/2017 4/23/2017 2

Growth as a Goal Widely held economic goal Growth leads to an increase in wages & improved standard of living Economy is better able to meet people’s wants & resolve socioeconomic problems 4/23/2017 4/23/2017 3

Arithmetic of Growth Small changes in growth make a HUGE difference Rule of 70 Tells us how many years it will take for real GDP to double Formula: 70/annual percentage rate of growth 4/23/2017 4/23/2017 4

Growth in the U.S. Since 1950, real GDP has increased about sixfold but the U.S. population has also increased Real GDP per capita has increased more than threefold Real GDP has grown at an annual rate of about 3.5 percent since 1950 and per capita has increased about 2.3 percent Reasons why: Improved products & services Added leisure (standard workweek has shrunk from 50 hours to approx. 35) Other impacts 2c. These measures of growth do not account for any effects growth may have on the environment & the quality of life. If growth hurts the environment and creates a stressful work environment, the growth numbers will overstate the gains in well-being that result from growth. 4/23/2017 4/23/2017 5

Uneven distribution of growth (8.2) The different starting dates for modern economic growth is the main cause of the differences in per capita GDP levels seen today Catching up is possible People can adopt technology more quickly than they can invent it Leader countries – inventing & implementing new technology is slow & costly so the growth is smaller Follower countries – can grow much faster because they simply adopt existing technology 1. Europe – early 1800’s…US, Canada, & Australia – mid 1800’s…Japan – 1870’s…rest of Asia – early to mid 1900’s…Central & South America & Middle East 4/23/2017 4/23/2017 6

Institutional structures that promote growth (8.3) Strong property rights Patents & copyrights Efficient financial institutions Literacy & widespread education Free trade A competitive market system These structures promote & sustain modern economic growth in poor follower countries People will not invest if they believe others will steal their investments or their expected returns. If society wants a constant flow of innovative new technologies & ideas, patents & copyrights are necessary. Before patents were issued, many inventors & authors had their ideas stolen before they could make a profit Needed to channel the savings generated by households toward the businesses, entrepreneurs, & inventors that do most of society’s investing & inventing. Without highly educated inventors, new technologies do not get developed. Promotes economic growth by allowing specialization 4/23/2017 4/23/2017 7

Ingredients of growth Supply factors Four of the ingredients of economic growth relate to the physical ability of the economy to expand Increases in the quantity & quality of natural resources Increases in the quantity & quality of human resources Increases in the supply (or stock) of capital goods Improvements in technology Demand factor Households, businesses, & government must purchase the economy’s expanding output of goods & services Efficiency factor To reach its full production potential, an economy must achieve economic efficiency as well as full employment 2a. When that occurs, there will be no unplanned increases in inventories & resources will remain fully employed. Economic growth requires increases in total spending to realize the output gains made available by increases production capacity. 3a. The economy must use its resources in the least costly way to produce the specific mix of goods & services that maximizes people’s well-being (allocative efficiency). Supply, demand, & efficiency factors in economic growth are related. Unemployment caused by insufficient total spending (demand factor) may lower the rate of new capital accumulation (supply factor) 4/23/2017 4/23/2017 8

Production possibilities analysis Labor & productivity – Society can increase its real output and income in two fundamental ways: Increasing its inputs of resources Raising the productivity of those inputs Real GDP = hours of work x labor productivity Hours of work Depends on size of employed labor force & length of average workweek Labor productivity Determined by technological progress, quantity of capital goods available to workers, quality of labor itself, & efficiency with which inputs are allocated, combined, & managed A nation’s economic growth from one year to the next depends on its increase in labor inputs (if any) and its increase in labor productivity (if any) 3. Productivity rises when the health, training, education, & motivation of workers improve; when workers have more & better machinery & natural resources with which to work/ when production is better organized & managed; and when labor is re-allocated from less-efficient industries to more-efficient industries. 4/23/2017 4/23/2017 9

Accounting for growth Growth accounting Used by Council of Economic Advisors (CEA) Assesses the relative importance of supply-side elements that contribute to changes in real GDP (i.e. hours of work & labor productivity) Labor inputs vs. labor productivity – When both are increasing, it’s an important sources of economic growth 4/23/2017 4/23/2017 10

Technological advance Largest contributor to productivity growth Accounts for about 40% of productivity growth Includes not only innovative production techniques but new managerial methods & new forms of business organization Generated by discovery of new knowledge which allows resources to be combined in improved ways that increase output 4/23/2017

Quantity of capital Increased capital explains roughly 30% of productivity growth More & better plant & equipment make workers more productive Some capital substitutes for labor, but most capital is complementary to labor (making labor more productive) 4/23/2017

Education & training Human capital Knowledge & skills that make a worker productive Investment in human capital Includes not only formal education but also on-the-job training An estimated 15% of productivity growth is derived from investments in people’s education & skills 4/23/2017

Economies of scale & resource allocation Explains the remaining 15% of productivity growth Reductions in per-unit production costs that result from increases in output levels Markets have increased in size over time This allows firms to increase output levels Able to use larger, more productive equipment Use new methods of manufacturing & delivery that increase productivity 4/23/2017

Improved Resource Allocation Means workers over time have moved from low-productivity employment to high-productivity employment I.E. moving from agriculture to manufacturing jobs to technology 4/23/2017

Recent productivity acceleration (8.4) Microchip & information technology Widespread availability of personal & laptop computers stimulated the desire to tie them together (Internet & e-commerce) First…Why has productivity increased relative to earlier periods? 4/23/2017 4/23/2017 16

New firms & increasing returns Increasing returns- situation in which a % increase in the amount of inputs a firm uses leads to an even larger % increase in the amount of output the firm produces Firms can exploit several different sources of increasing returns & economies of scale More specialized inputs Spreading of development costs Simultaneous consumption Network effects Learning by doing 2a. Firms can use more specialized & thus more productive capital & workers as they expand their operations. 2b. Firms can spread high product development costs over greater output 2c. Many recently developed products & services can satisfy large numbers of customers at the same time (i.e. computer software delivered on a CD at very low expense) 2d. Increases in the value of the product to each user, including existing users , as the total # of users rises. I.E. Software & Internet service become more beneficial to a buyer the greater the # of households and businesses that also buy them. 2e. Firms that produce new products or pioneer new ways of doing business experience increasing returns by learning by doing. 4/23/2017

What can we conclude? Prospects for a lasting increase in productivity growth are good Time will tell if productivity growth will be a long-run sustainable trend 4/23/2017 4/23/2017 18

Is growth desirable & sustainable? Antigrowth view Critics state that growth results in pollution, global warming, ozone depletion, & other environmental problems. Also, little evidence that economic growth solves problems such as poverty, homelessness, & discrimination 4/23/2017 4/23/2017 19

In defense of economic growth Enables a society to do the following: Improve the nation’s infrastructure Enhance care for the sick & elderly Provide greater access for the disabled Provide more police & fire protection 4/23/2017