© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair Prepared by: Fernando & Yvonn Quijano 18 Chapter Long-Run Growth

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 2 of 38 Chapter Outline 18 Long-Run Growth The Growth Process: From Agriculture to Industry The Sources of Economic Growth An Increase in Labor Supply Increases in Physical Capital Increases in Human Capital Increases in Productivity Growth and Productivity in the United States Sources of Growth in the U.S. Economy: 1929–1982 Labor Productivity: 1952 I–2005 II Economic Growth and Public Policy Suggested Public Policies Growth Policy: A Long-Run Proposition The Pros and Cons of Growth The Progrowth Argument The Antigrowth Argument Summary: No Right Answer

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 3 of 38 LONG-RUN GROWTH economic growth An increase in the total output of an economy. Defined by some economists as an increase of real GDP per capita. modern economic growth The period of rapid and sustained increase in real output per capita that began in the Western world with the Industrial Revolution.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 4 of 38 THE GROWTH PROCESS: FROM AGRICULTURE TO INDUSTRY FIGURE 18.1 Economic Growth Shifts Society’s Production Possibility Frontier Up and to the Right

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 5 of 38 THE GROWTH PROCESS: FROM AGRICULTURE TO INDUSTRY Beginning in England around 1750, technical change and capital accumulation increased productivity significantly in two important industries: agriculture and textiles. More could be produced with fewer resources, leading to new products, more output, and wider choice. A rural agrarian society was very quickly transformed into an urban industrial society. From Agriculture to Industry: The Industrial Revolution

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 6 of 38 Among the sources of increased productivity and growth in England around 1750 was: a.Technical change and capital accumulation. b.New and more efficient methods of farming. c.New inventions and new machinery. d. All of the above.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 7 of 38 Among the sources of increased productivity and growth in England around 1750 was: a.Technical change and capital accumulation. b.New and more efficient methods of farming. c.New inventions and new machinery. d. All of the above.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 8 of 38 THE GROWTH PROCESS: FROM AGRICULTURE TO INDUSTRY Economic growth continues today, 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 (capital), a better-educated and more highly skilled workforce (human capital), and increasingly from innovation and technical change (new techniques of production) and newly developed products and services. Growth in Modern Society

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 9 of 38 THE SOURCES OF ECONOMIC GROWTH aggregate production function The mathematical representation of the relationship between inputs and national output, or gross domestic product. An increase in GDP can come about through: 1.An increase in the labor supply 2.An increase in physical or human capital 3.An increase in productivity (the amount of product produced by each unit of capital or labor)

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 10 of 38 THE SOURCES OF ECONOMIC GROWTH AN INCREASE IN LABOR SUPPLY TABLE 18.1 Economic Growth from an Increase in Labor—More Output but Diminishing Returns and Lower Labor Productivity PERIOD QUANTITY OF LABOR L (HOURS) QUANTITY OF CAPITAL K (UNITS) TOTAL OUTPUT Y (UNITS) MEASURED LABOR PRODUCTIVITY Y/L labor productivity Output per worker hour; the amount of output produced by an average worker in 1 hour.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 11 of 38 THE SOURCES OF ECONOMIC GROWTH TABLE 18.2 Employment, Labor Force, and Population Growth, 1947–2004 CIVILIAN NONINSTITUTIONAL POPULATION OVER 16 YEARS OLD (MILLIONS) CIVILIAN LABOR FORCE EMPLOYMENT (MILLIONS) Number (Millions) Percentage of Population Percentage change, 1947 – % % % Annual rate+ 1.4%+1.6%+ 1.6% Source: Economic Report of the President, 2005, Table B-35. As long as the economy and the capital stock are expanding rapidly enough, new entrants into the labor force do not displace other workers.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 12 of 38 In order for economic growth to increase the standard of living: a.The rate of output growth must exceed the rate of population increase. b.Income must be distributed equally. c.The government must practice industrial policy. d.Citizens must experience improvements in the quality of life.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 13 of 38 In order for economic growth to increase the standard of living: a.The rate of output growth must exceed the rate of population increase. b.Income must be distributed equally. c.The government must practice industrial policy. d.Citizens must experience improvements in the quality of life.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 14 of 38 THE SOURCES OF ECONOMIC GROWTH INCREASES IN PHYSICAL CAPITAL TABLE 18.3 Economic Growth from an Increase in Capital—More Output, Diminishing Returns to Added Capital, Higher Measured Labor Productivity PERIOD QUANTITY OF LABOR L (HOURS) QUANTITY OF CAPITAL K (UNITS) TOTAL OUTPUT Y (UNITS) MEASURED LABOR PRODUCTIVITY Y/L

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 15 of 38 THE SOURCES OF ECONOMIC GROWTH TABLE 18.4 Fixed Private Nonresidential Net Capital Stock, 1960–2003 (Billions of 2000 Dollars) EQUIPMENTSTRUCTURES , ,108.53, ,910.04, ,613.35, ,138.56, ,523.36,525.8 Percentage change, 1960 – %+187.1% Annual rate+4.6%+ 2.5% Source: Survey of Current Business, September 2004, Table 15, p. 42 and author’s estimates.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 16 of 38 THE SOURCES OF ECONOMIC GROWTH INCREASES IN HUMAN CAPITAL TABLE 18.5 Years of School Completed by People Over 25 Years Old, 1940–2003 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. Source: Statistical Abstract of the United States, 1990, Table 215; and 2005, Table 212.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 17 of 38 THE SOURCES OF ECONOMIC GROWTH INCREASES IN PRODUCTIVITY productivity of an input The amount of output produced per unit of an input. invention An advance in knowledge. Technological Change innovation The use of new knowledge to produce a new product or to produce an existing product more efficiently.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 18 of 38 An increase in GDP can come about through: a.An increase in the labor supply. b.An increase in physical or human capital. c.An increase in productivity (the amount of product produced by each unit of capital or labor). d.All of the above.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 19 of 38 An increase in GDP can come about through: a.An increase in the labor supply. b.An increase in physical or human capital. c.An increase in productivity (the amount of product produced by each unit of capital or labor). d.All of the above.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 20 of 38 THE SOURCES OF ECONOMIC GROWTH Other Advances in Knowledge In addition to managerial knowledge, improved personnel management techniques, accounting procedures, data management, and the like can also make production more efficient, reduce costs, and increase measured productivity. Economies of Scale External economies of scale are cost savings that result from increases in the size of industries. Other Influences on Productivity

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 21 of 38 GROWTH AND PRODUCTIVITY IN THE UNITED STATES TABLE 18.6 Growth of Real GDP in the United States, 1871–2000 PERIOD AVERAGE GROWTH RATE PER YEARPERIOD AVERAGE GROWTH RATE PER YEAR Sources: Historical Statistics of the United States: Colonial Times to 1970, Tables F47-70, F98-124; U.S. Department of Commerce, Bureau of Economic Analysis.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 22 of 38 The average growth rate of real GDP in the United States was highest during the following period: a b c d

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 23 of 38 The average growth rate of real GDP in the United States was highest during the following period: a b c d

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 24 of 38 GROWTH AND PRODUCTIVITY IN THE UNITED STATES TABLE 18.7 Growth of Real GDP in the United States and Other Countries, 1986–2004 COUNTRY AVERAGE GROWTH RATE PER YEAR United States3.1 Japan2.3 Germany2.0 France2.2 Italy1.8 United Kingdom2.7 Canada2.8 Africa2.8 Asia (excluding Japan)9.1 India5.8 Source: Economic Report of the President, 2005, computed from Table B-112.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 25 of 38 GROWTH AND PRODUCTIVITY IN THE UNITED STATES SOURCES OF GROWTH IN THE U.S. ECONOMY: 1929–1982 TABLE 18.8 Sources of Growth in the United States, 1929–1982 PERCENT OF GROWTH ATTRIBUTABLE TO EACH SOURCE 1929 – – – – 1979 Increases in inputs Labor Capital Education (human capital) Increases in productivity Advances in knowledge Other factors a  2 Annual growth rate in real national income a Economies of scale, weather, pollution abatement, worker safety and health, crime, labor disputes, and so forth. Source: Edward Denison, Trends in American Economic Growth, 1929–1982 (Washington: Brookings Institution, 1985). Reprinted with permission of The Brookings Institution.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 26 of 38 GROWTH AND PRODUCTIVITY IN THE UNITED STATES TABLE 18.9 Sources of U.S. Growth, 1973–2000 Percent Contribution Increases in inputs Labor Capital IT capital Non-IT capital3826 Increases in productivity91017 Source: Dale Jorgenson and Kazuyuki Motohashi, “Economic Growth of Japan and the United States in the Information Age,” Rieti Discussion Paper Series 3-E-015. Cited with the permission of the authors.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 27 of 38 GROWTH AND PRODUCTIVITY IN THE UNITED STATES FIGURE 18.2 Output per Worker Hour (Productivity), 1952 I–2005 II LABOR PRODUCTIVITY: 1952 I–2003 II

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 28 of 38 ECONOMIC GROWTH AND PUBLIC POLICY SUGGESTED PUBLIC POLICIES Policies to Improve the Quality of Education Policies to Increase the Saving Rate Policies to Stimulate Investment Policies to Increase Research and Development Reduced Regulations Industrial Policy industrial policy Government involvement in the allocation of capital across manufacturing sectors.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 29 of 38 The accumulation of capital in an economy is ultimately constrained by: a.The rate of saving. b.The rate of spending relative to income growth. c.Depreciation. d.Government spending and taxation.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 30 of 38 The accumulation of capital in an economy is ultimately constrained by: a.The rate of saving. b.The rate of spending relative to income growth. c.Depreciation. d.Government spending and taxation.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 31 of 38 ECONOMIC GROWTH AND PUBLIC POLICY GROWTH POLICY: A LONG-RUN PROPOSITION The fact that progrowth policies can be costly in the short run and do not produce measurable results for a long time often pushes them far down on politicians’ lists of priorities.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 32 of 38 What is industrial policy? a.Industrial policy calls for the elimination of government intervention in business activities. b.Industrial policy calls for government involvement in the allocation of capital across manufacturing sectors. c.Industrial policy calls for the promotion of competition among domestic and foreign business firms. d.Industrial policy government spending and taxation that favors all business firms in the economy equally.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 33 of 38 What is industrial policy? a.Industrial policy calls for the elimination of government intervention in business activities. b.Industrial policy calls for government involvement in the allocation of capital across manufacturing sectors. c.Industrial policy calls for the promotion of competition among domestic and foreign business firms. d.Industrial policy government spending and taxation that favors all business firms in the economy equally.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 34 of 38 THE PROS AND CONS OF GROWTH THE PROGROWTH ARGUMENT Advocates of growth believe that: -Growth is progress. -Capital accumulation and new technology improve the quality of life. -Growth saves the most valuable commodity— time. -Growth improves the quality of things that yield satisfaction directly. -Growth produces jobs and higher incomes. With higher incomes we can better afford the sacrifices needed to help the poor. -When population growth is not accompanied by growth in output, unemployment and poverty increase.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 35 of 38 THE PROS AND CONS OF GROWTH THE ANTIGROWTH ARGUMENT Growth Has Negative Effects on the Quality of Life Growth Encourages the Creation of Artificial Needs consumer sovereignty The notion that people are free to choose, and that things that people do not want will not sell. “The consumer rules.” Those who argue against economic growth generally make the following four major points:

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 36 of 38 THE PROS AND CONS OF GROWTH Growth Means the Rapid Depletion of a Finite Quantity of Resources Growth Requires an Unfair Income Distribution and Propagates It

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 37 of 38 SUMMARY: NO RIGHT ANSWER Society must make some hard choices, and there are many trade-offs. As long as these trade-offs exist, people will disagree. The debate in contemporary politics is largely about the costs and benefits of shifting more effort toward the goal of economic growth and away from environmental and social welfare goals.

CHAPTER 18: Long-Run Growth © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 38 of 38 aggregate production function consumer sovereignty economic growth industrial policy innovation invention labor productivity modern economic growth productivity of an input REVIEW TERMS AND CONCEPTS