PART SEVEN Economic Growth and International Economics

Chapter 17: Economic Growth Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Economic Growth Economic growth is the expansion of real GDP (or real GDP per capital) over time. U.S. real GDP (adjusted for inflation) increased from $1,177 billion in 1950 to $10,842 billion in U.S. real GDP Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Ingredients of Growth Three key factors interact in a dynamic process to ensure economic growth. The six main ingredients include four supply factors, a demand factor and an efficiency factor. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Supply Factors Supply factors relate to the physical ability of the economy to expand. Increases in the quantity and quality of natural resources and human resources, as well as the growth in the supply of capital goods and improvements in technology, will enable an economy to expand its potential GDP.

Demand Factor Households, businesses, and government demand contribute to economic growth through the purchasing of the economy’s expanded output of goods and services. An increase in total spending in response to an increase in output ensures that there will be no unplanned inventories and resources will remain fully employed.

Efficiency Factor To reach its production potential, an economy must achieve economic efficiency as well as full employment. This can be done as long as the economy achieves both productive efficiency (using resources efficiently) and allocative efficiency (producing products that maximize people’s well-being).

Production Possibilities Analysis Production possibilities analysis can help illustrate the six factors underlying economic growth. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Growth and Production Possibilities An improvement in any of the four supply factors that shift the production possibilities curve outward, from AB to CD. The demand factor and efficiency factor will move the economy from point a to point b. [ Insert Figure 1.2 here] Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Production Possibilities and Aggregate Supply Economic growth can also be thought of as an expansion of an economy’s long-run aggregate supply. As an economy expands, the long-run aggregate supply curve shifts to the right. Recall that the AS LR is a vertical line, located at the economy’s potential (full employment) level of output. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Production Possibilities and Aggregate Supply Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Inputs and Productivity A country’s real GDP depends on the amount of inputs and the productivity of these inputs in any given year. Likewise, economic growth from one year to the next depends on increases in inputs and increases in the inputs’ productivities. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Labor and Labor Productivity The input of labor can be used to illustrate the role of supply factors in economic growth. An increase in hours of work due to a longer average workweek or a larger labor force couple with in increase in labor productivity can contribute to higher economic growth. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Growth Accounting Growth accounting is the bookkeeping of the supply-side elements that contribute to changes in real GDP. The Council of Economic Advisers (CEA) uses this method to assess the factors underlying economic growth.Council of Economic Advisers (CEA) Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Accounting for Growth Government data from the CEA shows that economic growth in the U.S. can be attributed to increases in the quantity of labor and rises in labor productivity. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Accounting for Growth Factors that contribute to productivity growth include technological advance, increased physical and human capital, economies of scale and improved resource allocation. Other factors such as the overall social- cultural-political environment of the U.S. have fostered economic growth. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

The Productivity Acceleration Between 1995 to 2004 period, the U.S. experienced higher productivity growth than in the 1973 to 1995 period. Some economists say the U.S. has achieved a New Economy, whereby accelerated productivity growth resulted from a significant new wave of technology and enhanced global competition. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Reasons for Productivity Acceleration in the New Economy The Microchip and Information Technology New Start-Up Firms Increasing Returns due to: More specialized inputs Spreading of development costs Simultaneous consumption Network effects Learning by doing Global Competition Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

The Productivity Acceleration Implicatively, stronger productivity growth and heightened global competition lead to higher rates of economic growth. However, skeptics question the permanence of long-term substantially higher rates of productivity growth. Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Is Growth Desirable and Sustainable? The Antigrowth View Results in pollution, global warming, ozone depletion and other environmental problems Many sociological problems still exist such as discrimination, poverty, homelessness Physical and mental health of workers impaired Speeds up degradation and exhaustion of the earth’s resources Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.

Is Growth Desirable and Sustainable? In Defense of Economic Growth Higher standard of living and material abundance Improvements in the nation’s infrastructure Enhanced health care Better public safety Safer work environment Copyright © 2007 by the McGraw-Hill Companies, Inc. All rights reserved.