1. Growth and Productivity: Long-Run Possibilities
Chapter 17

2. Introduction This chapter considers three questions:
How important is economic growth?
How does an economy grow?
Is continued economic growth possible? Is it desirable?

3. The Nature of Growth
There are two distinct ways in which output increases.
Increased use of existing productive resources.
Expansion of productive capacity.

4. Two Types of Growth THE SHORT RUN: THE LONG RUN: Investment Goods C B
Consumption Goods
Investment Goods C B B A A

5. Short-Run Changes in Capacity Utilization
Economic growth refers to increases in the output of the economy.
The easiest kind of growth comes from increased use of our existing productive capabilities.

6. Short-Run Changes in Capacity Utilization
An economy moves to a point on the production-possibilities curve when it uses all of its resources.
Production possibilities – The alternative combinations of final goods and services that could be produced in a given time period with all available resources and technology.

7. Short-Run Changes in Capacity Utilization
Getting to a point on the production possibilities curve involves pursuing the short-run goal of full employment.

8. Long-Run Changes in Capacity
To achieve large and lasting increases in output, we must push our production-possibilities outward.

9. Long-Run Changes in Capacity
Economists usually choose to define economic growth in terms of potential GDP.
Economic growth is an increase in output (real GDP) – an expansion of production possibilities.

10. Long-Run Changes in Capacity
Economic growth implies a rightward shift of the long-run aggregate supply curve.

11. Shifts in Long-Run Supply
Real Output (dollars per year)
Price Level (average price)
LRAS1
LRAS2 E2 E3 E1
AD2 AS
AD1

12. 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.

13. Nominal vs. Real GDP
Growth is measured in real goods and services, not inflation distorted dollars.
Base Period - The time period used for comparative analysis; the basis of indexing (e.g., of price changes).

14. Measures of Growth
Changes in real GDP are presented in percentage terms as a growth rate.

15. The Growth Rate
Growth rate is the percentage change in real output from one period to another.
It is calculated as the change in real output between two periods divided by the total output in the base year.

16. Recent U.S. Growth Rates
8.0
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
6.0
4.0
2.0
–2.0
–3.0
–1.0
1.0
3.0
5.0
7.0

17. The Exponential Process
The growth of the economy is an exponential process.
Small economic growth compounds from year to year.

18. The Exponential Process
GDP doubles in 28 years at a growth rate of 2.5%.
GDP doubles in 20 years at a growth rate of 3.5%.

19. GDP per Capita: A Measure of Living Standards
The exponential process might look even more meaningful if we translate it into per capita terms.
GDP per capita – Total GDP divided by total population: average GDP.

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

21. GDP per Worker: A Measure of Productivity
One reason GDP per capita has risen in recent years is that the labor force grew faster than the population.
Labor Force – All persons over age 16 who are either working for pay or actively seeking paid employment.

22. GDP per Worker: A Measure of Productivity
The employment rate cannot rise forever.
Employment rate – The percentage of the adult population that is employed.

23. GDP per Worker: A Measure of Productivity
Further increases in GDP per capita can only come from increases in output per worker.
The most common measure of productivity is output per labor hour.

24. GDP per Worker: A Measure of Productivity
Productivity is measured as output per unit of input, for example, output per labor-hour.

25. A Rising Employment Rate65 64 63 62 61 60 59 58 57 56 55
1975
1980
1985
1990
1995
2000
Employment Rate (percent of population)

26. The Productivity Turnabout
For economic growth to continue, the productivity of the average U.S. worker must rise still further.

27. Output per Hour in the Nonfarm Business Sector
Productivity Gains
Output per Hour in the Nonfarm Business Sector
100
110
120 90 80 70
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
Actual
1.4 percent average annual growth 1973 to 1995
2.6 percent average annual growth 1995 to 2000
Index, 1992 = 100

28. Source of Growth Future growth depends on two factors:
Growth rate of the labor force.
Growth rate of productivity.

29. Source of Growth The 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 - the development and use of better capital equipment and products.
Improved management - better use of available resources in the production process.

30. Human-Capital Investment
Continuing advance in education and skills training have greatly increased the quality of U.S. labor.

31. Human-Capital Investment
The gains in productivity reflect greater human capital investment.
Human capital is the knowledge and skills possessed by the labor force.

32. Physical-Capital Investment
A primary determinant of labor productivity is the rate of capital investment.

33. 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 is gross investment less depreciation.

34. Household and Business Saving
Household saving rates in the U.S. are notoriously low.
Virtually all U.S. investment has been financed with business saving and foreign investment.

35. Foreign Investment
Foreign investors have poured money into U.S. plant, equipment, software, and financial needs.

36. Management Training
How well resources are organized and managed will affect the rate of growth.
U.S. corporations spend billions of dollars on management training.
Such investments in managerial talent are another source of economic growth.

37. Research and Development
Research and development includes scientific research, product development, innovations in production techniques, and the development of management improvements.

38. Research and Development
Research and development is a vital source of productivity advances and is credited with the greatest contributions to economic growth.

39. New Growth Theory
The evident contribution of “advances in knowledge” to economic growth has spawned a new perspective called “new growth theory”.

40. New Growth Theory
“Old growth theory” emphasized the importance of bricks and mortar, that is saving and investing in new plant and equipment.

41. New Growth Theory
“New growth theory” emphasizes the importance of investing and spreading knowledge and ideas.

42. Sources of U.S. Growth

43. Policy Levers
Once the sources of growth are known, policies for accelerating long-run economic growth can be developed.

44. Policy Levers
Most of the policy options are distinctly micro in nature, although macro policy decisions are also important.

45. Increasing Human Capital Investment
Governments invest in human-capital development by building, operating, and subsidizing schools.

46. Increasing Human Capital Investment
Immigration laws that promote immigration of skilled workers determine a nation’s stock of human capital.

47. Increasing Physical Capital Investment
As in the case of human capital, the possibilities for increasing physical-capital investment are also many and diverse.

48. Investment Incentives
The tax code offers mechanisms for stimulating investment:
Faster depreciation schedules.
Tax credits for new investments.
Lower business tax rates.

49. Savings Incentives
The government can use the tax code to deepen the savings pool that finances investment.
Tax preferences for Individual Retirement accounts.

50. Infrastructure Development
The government also directly affects the level of physical capital through its public works spending.
Bridges, highways, etc.
Airports.
Water and sewer systems.

51. Fiscal Responsibility
Short-run government policies may lead to a crowding out of consumer saving and investment.
Crowding out – A reduction in private-sector borrowing (and spending) caused by increased government borrowing.

52. Fiscal Responsibility
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.

53. 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.

54. Institutional Context
The 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.

55. Limitless Growth
Is it possible to have limitless economic growth?

56. The Malthusian Formula for Destruction
In 1798, Reverend Thomas Malthus predicted future starvation for England.

57. The Malthusian Formula for Destruction
His prediction was based on the limits to food production accompanied with high population growth.

58. The Malthusian Formula for Destruction
Malthus believed population would increase following a geometric growth path with the food supplies only following an arithmetic growth path.

59. Limits to Food Production
Geometric growth – an increase in quantity by a constant proportion each year.
Arithmetic growth – an increase in quantity by a constant amount each year.

60. Limits to Food Production
Output, including agricultural products, has increased at a geometric rate, not at the much slower arithmetic rate foreseen by Malthus.

61. The Malthusian Doomsday
MILLIONS
Barley and oats (bushels)
Population
Wheat
Malthus' projections of population and food supply
Malthus' projections of declining per capita food output
1800
1850
1900
1950
2000
2,400
2,000
1,600
1,200
800
400
BUSHELS PER CAPITA 24 4 8 20 16 12
Barley and oats

62. Resource Constraints
To keep growing, we will need still more productivity improvements and assured resource availability.

63. Resource Constraints
All doomsday predictions ignore the role of markets in both promoting more efficient uses of scarce resources and finding substitutes for them.

64. Environmental Destruction
Pollution levels have risen along with GDP and population expansion.
With current and future pollution-abatement policies, the rate of pollution does not have to increase unabated.

65. The Possibility of Growth
There probably are no limits to growth, at none emanating from resource constraints or pollution thresholds.

66. The Desirability of Growth
Continued economic growth is desirable so long as it brings a higher standard of living and an increased ability to produce and consume socially desirable goods and services.

67. Growth and Productivity: Long-Run Possibilities
End of Chapter 17