1. Extension Chapter 5 The economics of growth

2. Learning objectives
Understand how growth is defined and why it is important.
Discuss the causes or ingredients of growth.
Describe the classical growth model and its implications.
Analyse how labour productivity and, therefore, living standards can be raised.
Develop a formal full-employment growth model.

3. Learning objectives (cont.)
Describe and explain the growth record of Australia.
Briefly survey growth policies.
Review the debate over the desirability of growth as an economic goal.
Examine whether continued economic growth is feasible.

4. Growth economics
The area of economics concerned with analysing the patterns of long-term trends in an economy’s productive capacity and factors that influence these trends.

5. Economic growth Economic growth is defined and measured in two ways:
Increase in real GDP over time (% p.a.)
e.g. comparing regional economic power or influence
Increase in real GDP per capita over time (% p.a.)
e.g. comparing standards of living

6. Importance of growth Greater ability to face economic challenges
Small changes in growth can dramatically affect a country’s economy.
Increased opportunities
Incomes, education, social welfare, environmental
Lessens the burden of scarcity
Allows economy to realise economic goals more fully.

7. Causes of growth Six strategic ingredients of growth
Supply factors: physical ability of economy to grow
Quantity and quality of natural resources
Quantity and quality of human resources
Supply or stock of capital goods
Technology
Aggregate demand factors
The demand factor
The efficiency factor

8. Determinants of real output

9. Supply factors
Growth is attributed to the availability of more and better resources, including the stock of technological knowledge.
Two ways to increase output:
increase in inputs of resources
increase in the quality or productivity of those inputs.
Labour force productivity
Labour productivity is the real output per worker per hour.
Total output = worker hours  labour productivity

10. Demand factors
A growing level of demand is required in order for the full-employment of an expanding supply of resources.
Demand and supply factors are interrelated.

11. Allocative factor
In order to achieve productive potential, a nation must:
have full-employment of resources
AND
achieve full production from resources.
Resources must be allocated to get the maximum amount of goods and services possible.

12. Production possibilities
Recall the production possibilities curve:
points on the curve represent maximum amounts of production
points inside the curve represent a failure to achieve full employment and full production.
Improvement in supply factors will shift the curve outwards.
Economy will not necessarily operate on the curve unless demand is sufficient and allocative efficiency is realised.

13. Economic growth and the production possibilities curve
Consumer
goods
Capital goods B A

14. Models of growth: the classical model
The classical model emphasises the supply side of economic growth
Determinants of the productive capacity of the economy
Interaction of two important factors:
law of diminishing returns
population growth.

15. Law of diminishing returns
As successive increments of one resource are added to a fixed resource, beyond some point, the resulting increases in total output will diminish in size.
Disproportionate increases in resources
e.g. large increases in labour, smaller increases in arable land

16. Population growth Optimum population
Population which, given the economy’s natural resources and technology, will yield the greatest income per person.
Population growth may be a mixed blessing.
Malthus’s thesis: Given diminishing returns, persistent and substantial population growth will force and maintain the standard of living close to the subsistence level (in less developed countries).
If population growth coincides with increases in labour productivity then rising standards of living will occur (in industrially advanced countries).

17. Aggregate expenditures and growth
Expanding levels of demand needed to achieve full-employment GDP
Investment can be:
income creating
capacity creating
capital–output ratio.

18. Equilibrium GDP with a rise in NX
C+G+I (billions of dollars) 45 o
Gross domestic product ($ billions)
510
490
470
450
(C + I + G )1
Full employment (Year 1)
(C + I + G )2
Full employment (Year 2)

19. Full-employment growth model
Emphasises:
the capacity-creating characteristics of net investment while accounting for income-creating aspects
role of saving
role of the capital-output ratio.

20. Full-employment growth model (cont.)
Capital–output ratio is the:
relationship between net increases in the size and value of the capital stock (net investment) and sustainable increases in real GDP (capacity output).
For example, ratio of 4:1 means for every $4 of net investment in year 1 the economy is capable of producing $1 of additional output in year 2 and succeeding years.

21. Full-employment growth model (cont.)
The full-employment growth model demonstrates that:
the economy’s full-employment growth rate can be calculated by dividing the average propensity to save (APS) by the capital–output ratio
the APS and the growth rate are directly related
the capital–output ratio and the growth rate are inversely related.

22. Australia’s growth record
In the past 50 years:
real GDP increased by 5.7 times
real GDP per capita increased by 2.6 times over the period.
Substantial improvements in product quality and leisure time have been made.
Growth has been less than in many other developed nations.

23. Sources of Australian growth
Labour inputs
Population growth
Immigration
Productivity increases
Technological progress
Stock of capital
Education and training
Allocative efficiency and growth
Other factors
Political stability
Social philosophy

24. Population and labour force growth in Australia, 1870–2009

25. Sources of population growth, 1949–50 to 2008–09

26. Growth policies
Growth policies represent purposeful actions on the government’s part to enhance the prospects of growth.
Policy depends on the school of thought, such as:
Keynesian policies stress low interest rates to stimulate I and outline role of government
supply-side policies emphasise tax cuts to enhance S & I, work effort and entrepreneurial activity
new-classical economics advocate minimum government intervention.

27. The case against growth
Pollution and environmental deterioration
Problem resolution
Does growth mean that poverty is eliminated?
Human obsolescence and insecurity
Increased insecurity as machines replace humans
Growth and human values

28. In defence of growth Improved living standards Environmental benefits
Control pollution not growth
Growth as a vehicle for reducing income inequality
Growth is more consistent with ‘the good life’ than is stagnation.

29. Are there limits to growth?
Club of Rome and the Doomsday models state that:
the growth paths of population, output and pollution are on a catastrophic collision course with production limits imposed by natural resources and the pollution-absorbing capacity of the environment.

30. Doomsday models Criticisms of the Doomsday models are:
they incorrectly assume fixity of natural resources
ignore the role of the price system and changing behavioural patterns
underestimate role of technology
underplay the impact of applying existing knowledge
underplay the impact of new resources and products
underestimate increasing returns to technology.

31. Next chapter Extension Chapter 6 The development of macroeconomic debates