1. Chapter 6: Economic Growth
Estimate economic growth and implications of sustained growth for standard of living.
Trends in economic growth in U.S. and rest of world.
Sources of economic growth
Alternative theories and policies to improve growth.

2. The Basics of Economic Growth
the sustained expansion of production possibilities
measured as the increase in real GDP over a given period.
Economic growth rate = annual % change of real GDP.
Between two consecutive years:
growth rate = (X2/X1)-1
Over several years:
Annualized growth rate = (XT/X1)1/T – 1

3. The Basics of Economic Growth
Standard of living depends on real GDP per person.
Real GDP per person grows only if real GDP grows faster than the population grows.
Rule of 70
number of years it takes for the level of a variable to double is approximately 70 divided by the annual percentage growth rate of the variable

5. Trends in U.S Economic Growth
Growth in the U.S. Economy
From 1908 to 2008, annual growth in real GDP per person in the United States averaged 2% .
Real GDP per person fell precipitously during the Great Depression and rose rapidly during World War II.
Growth was most rapid during the 1960s.
Growth slowed during the 1970s and sped up again in the 1980s and1990s.

6. Economic Growth Trends

8. Economic Growth in U.S. vs. Poor Countries
The gaps between real GDP per person in the United States and in these countries have widened.
Some economies are converging
Some are diverging

9. Sources of Economic Growth
Economic growth is the sustained, year-on-year increase in potential GDP.
Potential GDP is the quantity of real GDP produced when the quantity of labor employed is the full-employment quantity.
Short run fluctuations in real GDP resulting from the business cycle are not the basis for economic growth

10. Determinants of Potential GDP
Aggregate production function
Real GDP changes as the quantity of labor changes, other things held constant.
An increase in labor increases real GDP.
Diminishing marginal returns cause RGDP to rise at slower rate as L rises

11. Determinants of Potential GDP
Aggregate Labor Market
real wage rate
money wage rate divided by the price level.
demand for labor
shows the quantity of labor demanded as a function of the real wage rate.
determined by the marginal product of labor
supply of labor
shows the quantity of labor supplied as a function of the real wage rate.

12. The Labor Market and Potential GDP
Labor Demand Curve
The demand for labor is the relationship between the quantity of labor demanded and the real wage rate when all other influences on hiring plans remain the same.
Marginal product of labor curve is same as labor demand curve
Firms will always hire workers if MP> real wage
Profit maximizing firm hires until MP= real wage
Start here

13. The Labor Market and Potential GDP
Labor supply curve
shows quantity of labor supplied for each real wage rate.
Quantity of labor supplied increases as the real wage rate increases for two reasons:
1. Hours per person increase (assuming IE<SE)
Income effect (work less if real wage increases)
Substitution effect (work more if real wage increases)
2. Labor force participation increases

14. Determinants of Potential GDP

15. How Potential GDP Grows
Increase in the supply of labor
taxes on workers
population growth
demographics
retirement incentives
household technology
Increase in demand for labor
more productive labor
Human capital
physical capital
technological improvements
reduced payroll taxes on employers
Start with labor demand in 9:30;

16. Effect of increase in labor supply
real wage
labor hours
real GDP
productivity (RDGP per hour)
real GDP per capita
depends on whether population increased

17. Effect of increase in labor demand due to increased productivity
Labor demand increases and PF shifts upward.
real wage
labor hours
real GDP
productivity
real GDP per capita
Start here in 8 a.m.

18. Why Labor Productivity Grows
The incentive system created by firms, markets, property rights, and money.
The growth of labor productivity depends on
Physical capital growth
Human capital growth
Technological advances
Start here

19. Accounting for Growth
The quantity of real GDP produced, Y, depends on the quantity of labor, L, the quantity of capital, K, and the state of technology, T.
Growth accounting
calculates the contribution of capital growth and technological change to labor productivity growth.
One third rule (Robert Solow)
Estimated effects of capital on labor productivity
On average, with no change in technology, a 1 percent increase in capital per hour of labor brings a 1/3 percent increase in labor productivity

20. Why Labor Productivity Grows
Between 1973 and 1983, growth of labor productivity slowed to 1.7 percent a year.
A collapse in the contribution of technological change (purple bar) brought about this slowdown in the growth of labor productivity.

21. Why Labor Productivity Grows
Labor productivity growth rate increased to 2 percent a year between 1983 and 1993 and …
to almost 3 percent between 1993 and 2008.
Technological change contributed most to this speedup in the growth of labor productivity.

22. Growth Theories and Policies
Classical growth theory
growth of real GDP per person is temporary and that when GDP per person rises above the subsistence level, a population explosion eventually brings real GDP per person back to the subsistence level.
Malthus – the “dismal science”

23. Growth Theories and Policies
Modern Growth Theory
Real GDP per person grows because technological change induces a level of saving and investment that makes capital per hour of labor grow.
Growth ends only if technological change and/or incentives for technological change stops.

24. Growth Theories and Policies
New growth theories
Real GDP per person grows because of choices that people make in the pursuit of profit and growth can persist indefinitely.
Technological change is driven by profit incentives
Knowledge is a public good and there may be increasing returns to knowledge (education)

25. Growth Theories and Policies
Achieving Faster Growth
Growth accounting tells us that to achieve faster economic growth we must either increase the growth rate of capital per hour of labor or increase the pace of technological change.
Stimulate Saving
Saving finances investment. So higher saving rates might increase physical capital growth.
Tax incentives might be provided to boost saving.

26. Growth Theories and Policies
Stimulate Research and Development
Because the fruits of basic research and development efforts can be used by everyone, not all the benefit of a discovery falls to the initial discoverer.
The market might allocate too few resources to research and development.
Government subsidies and direct funding might stimulate basic research and development.
Patents can provide incentive to innovate.