Chapter 8
Macroeconomic Goal: Economic Growth
Lectures
For Online Lecture see: http://www.harpercollege.edu/mhealy/eco212i/lectures/ch8-18.htm

Recession is over: http://money.cnn.com/2009/10/29/news/economy/gdp/index.htm

8a Economic Growth

I. Introduction

A. Macroeconomic Goals
1. Full Employment
2. Low Inflation
3. Economic Growth 

II. Definitions of Economic Growth
Note: in chapter 8 the textbook gives two definitions and in chapter one a third definition

A. Definitions of economic growth
  1. INCREASING OUR POTENTIAL OUTPUT (Ch. 1 - an increase in the ability to produce)
  2. ACHIEVING OUR POTENTIAL OUTPUT (Ch 8 an increase in real GDP)
  3. Increase in real GDP PER CAPITA

 

1. INCREASING THE POTENTIAL REAL GDP (increasing our ABILITY to Produce, Ch. 1, 5Es Definition)
a. "economic growth" on the 5Es chart

b. production possibilities curve

 

c. AD and AS model: ­AS

causes:

In the 5 Es lecture we said that economic growth is caused by:
  1. more resources
  2. better resources, or
  3. better technology

An increase in the production possibilities curve is caused by having more resources, better resources, or better technology.

An increase in AS is caused by:

  1. a decrease in the price of resources
  2. an increase in productivity
  3. lower business taxes and government red tape

These are all really the same thing.

d. LRAS Model (long run AS )

more later

 

2. ACHIEVING THE POTENTIAL REAL GDP
Increasing Real GDP (producing more, definition often used in the news)
"Ch. 8 definition"

 

a. achieving "full employment" and "productive efficiency" (5Es)

 

b. production possibilities curve

c. AD and AS model: ­AD

 

3. increasing GDP per capita

  • This definition is superior if comparison of living standards is desired. For example, China's 2001 GDP was $1131 billion compared to Denmark's $166 billion, but per capita GDP's was $890 and $31,090 respectively.
  • Growth in real GDP does not guarantee growth in real GDP per capita. If the growth in population exceeds the growth in real GDP, real GDP per capita will fall.

 

 

B. A new model to illustrate the first definition (INCREASING THE POTENTIAL REAL GDP)
The Long Run AS (LRAS) Model

 

 

 1. What is the LRAS curve?

AS when all resources can be changed

a. What happens IN THE LONG RUN if there is an increase in the short run AD?

(1)First, if there is an increase in AD (from AD1 to AD2)

(2) then, the price level will increase from P1 to P2

(3) a higher price level will cause an increase in the price of resources

(4) higher resource prices is a determinant of AS, so AS decreases from AS1 to AS2

(5) RESULT: in the long run the level of real domestic output will stay at the full employment level (Qf)

 

b. What happens in the long run if there is an initial DECREASE in short run AD?

 

(1) If there is an decrease in AD (from AD1 to AD2)

(2) then the price level will decrease from P1 to P2

(3) a lower price level will cause an decrease in the price of resources

(4) lower resource prices is a determinant of AS, so AS increases from AS1 to AS2

(5) RESULT: in the long run the level of real domestic output will stay at the full employment level (Qf)

 

2. With this new model in increase in economic growth will be represented as:

NOTE: this is INCREASING THE POTENTIAL GDP

 

III. Economic Growth in the United States

A. Growth is an important economic goal because it means more material abundance and ability to meet the economizing problem. Growth lessens the burden of scarcity. That is why we study it.

B. The arithmetic of growth is impressive.

  • Using the "rule of 70," a growth rate of 2 percent annually would take 35 years for GDP to double,
  • but a growth rate of 4 percent annually would only take about 18 years for GDP to double.
  • The "rule of 70" uses the annual rate of change, divides it into 70, and the result is the number of years it takes the underlying quantity to double.)
    • Note:
      • small changes in the annual percent growth of GDP results in large changes in GDP over time
      • know the "rule of 70"

C. Main sources of growth are increasing inputs or increasing productivity of existing inputs.

1. About one-third of U.S. growth comes from more inputs.

2. About two-thirds comes from increased productivity.

  • Note:
    • we said economic growth is cause by:
      • more resources
      • better resources = greater productivity
      • better technology = greater productivity
    • here the authors are discussing an INCREASE in POTENTIAL GDP

E. Growth Record of the United States (Table 8.1) is impressive.

Table 8.1

 

1. Real GDP has increased over six fold since 1950, and real per capita GDP has risen over threefold. (See columns 2 and 4, Table 8.1)

2. Rate of growth record shows that real GDP has grown about 3.2 percent per year between 1950 and 2009, and real GDP per capita has grown about 2 percent per year. But the arithmetic needs to be qualified.

  • impoved products and services
  • added leisure (shorter average work week)
  • other impact on the environment, etc.

 

IV. Modern Economic Growth

A. Modern economic growth is characterized by sustained ongoing increases in living standards that can cause dramatic increases in the standard of living within a generation.

B. Economic historians informally date the start of the Industrial Revolution to the year 1776, when Scottish inventor James Watt perfected a powerful and efficient steam engine.

Note:

  • there was little to no growth in living standards from the beginning of time to about 200 years ago
  • during this period of little or no growth all areas of the world had similar standards of living
  • therefore the type of economic growth that we see now is a recent phenomenon in the history of the world
  • also, the great differences in living standards is a recent phenomenon in the history of the world

 

  • How does "modern economic growth" differ from what came before it?

C. The Uneven Distribution of Growth

1. Modern economic growth has spread only slowly from its British birthplace. It first advanced to France, Germany, and other parts of Western Europe in the early 1800's before spreading to the Untied States, Canada, and Australia by the mid 1800's.

2. The different starting dates for modern economic growth in various parts of the world are the main cause of the vast differences in per capita GDP levels seen today.

3. Figure 8.1 shows what economists have called the great divergence in income levels around the world as a result of different rates of, and starting dates for, modern economic growth.

  • What is the "great divergence"?
  • According to the textbook, what is the main cause for the "vast differences in in per capita income levels seen today?

D. Catching Up is Possible

1. Countries that began modern economic growth more recently are not doomed to be permanently poorer than the countries that began modern economic growth at an earlier date.

2. The poorer 'follower countries' can grow much faster because they can simply adopt existing technologies from rich 'leader countries'.

3. Table 8.2 shows both

  • how the growth rates of leader countries are constrained by the rate of technological progress
  • as well as how certain follower countries have been able to catch up by adopting more advanced technologies and growing rapidly.

    Table 8.2

  • which countries are the "leader countries" and which are the "follower countries" in 1960?
  • notice that the average growth rates for the these follower countries is higher than for the leader countries
  • notice that with these growth rate differences some follower countries have surpassed some leader countries in real GDP per capita
  • According to the authors, why is the real GDP per capita of the United States in 2007 so much higher than that of other rich countries?
    • larger fraction of populaiton is working in the US
    • longer work weeks in US

     

V. Institutional Structures That Promote Growth

A. Table 8.2 demonstrates that poorer follower countries can catch up. But how does a country start that process?

B. Economic historians have identified several institutional features that promote and sustain modern economic growth.

1. Strong Property Rights

2. Patents and copyrights (see the CONSIDER THIS … Patents and Innovation)

3. Efficient financial institutions

4. Literacy and widespread education

5. Free trade

6. A competitive market system

 

Note the role of Structural Adjustment that we studied in unit 1:

  • strong property rights - privatization
  • free trade
  • a competitive market system

The textbook lists some other "difficult-to-measure" factors that help economic growth:

  • stable political system
  • internal order (no civil wars)
  • strong sense of the right of property ownership
  • strong legal status accorded to businesses
  • strong laws to enforce contracts
  • "no social or moral taboos on production and material progress"
  • belief that wealth creation is a desirable goal
  • positive attitude toward work

 

  • I would add that the more equal status afforded to women in the leader countries has aided economic growth

 

VI. Determinants of Growth - SIX FACTORS from the textbook

A. Four supply factors relate to the ability to grow. - INCREASE THE POTENTIAL
1. The quantity and quality of natural resources,

2. The quantity and quality of human resources,

3. The supply or stock of capital goods, and

4. Technology.

This is the same as:

  • more resources
  • better resources
  • better technology

B. Two demand and efficiency factors are also related to growth - ACHIEVE THE POTENTIAL

1. Aggregate demand must increase for production to expand.

2. Full employment of resources and productive efficiency are necessary to get the maximum amount of production possible.

 

C. Production Possibilities Analysis (Figure 8.2)
1. Supply Factors shift the production possibilities outward from AB to DC in Figure 8.2 below

2. After the supply factors shift the production possibilities the demand and productive efficiency factors move the economy from a to c or b on the production possibilities graph in Figure 8.2 below.

Figure 8.2

D. AS-AD Analysis

1. Supply Factors shift the AS outward from AS to AS in Figure below

2. After the supply factors shift the production possibilities the demand and productive efficiency factors increase AD from AS to AD'

1. Aggregate demand must increase to sustain full employment at each new level of production possible.

E. WE NEED BOTH TYPES OF "ECONOMIC GROWTH" TO MAXIMIZE SOCIETY'S SATISFACTION

VII. Accounting for Growth

Table 8.3

Average annual percentage changes in the growth of real GDP in the US and how much was the result of an increase in the quantity of labor and how much was the result of an increase in the productivity of labor

A. More labor input is one source of growth.

  • Labor force has grown by 1.7 million workers per year for the past 52 years
  • accounts for about one-third of total economic growth.

B. The growth of labor productivity

  • contributed only about half of the growth from 1973-1993,
  • but was responsible for all it from 1995-2004, and
  • is expected to account for about three-fourths of the growth between 2005 and 2011. 

C. WHAT CAUSED THE INCREASE IN PRODUCTIVITY

  • According to Table 8.3 between half and three quarters of economic growth in the US during the past 50 -60 year is can be explained by an increase in the productivity of labor (output per worker)

 

  • Four causes of an increase in the productivity of labor:
    • 1. Technological advance, the most important factor in productivity growth, accounts for 40 percent of productivity growth.

      2. Increases in quantity of capital are estimated to explain about 30 percent of productivity growth.

      3. Education and training improve the quality of labor, and account for about 15 percent of productivity growth. (See Figure 8.4 below)

      4. Improved resource allocation and economies of scale also contribute to growth and explain about 15% of total productivity growth.

      a. Economies of scale occur as the size of markets and firms that serve them have grown.

      • b. Improved resource allocation has occurred as discrimination disappears and labor moves where it is most productive, and as tariffs and other trade barriers are lowered.

        Figure 8.4 - Changes in the educational attainment of the U.S. adult population

       

     See this

    Note:

    • the quantity of labor does NOT affect the productivity of labor
    • more workers would mean more production
    • but more workers does not necessarily mean more productivity (more BETTER workers would increase productivity)
    • Know the difference between:
      • production - the quantity that is produced (the production of cars increased last month)
      • productive efficiency - producing at the minimum cost (one of the 5Es)
      • productivity - how much is produced per unit of rescues (output per worker per hour)
    • the quantity of labor affects economic growth and the productivity of labor affects economic growth, but just because we have more workers doesn't mean that we have better workers

D. CONSIDER THIS … Women, the Labor Force, and Economic Growth

1. The percentage of women working in the paid labor force has risen from 40 percent in 1965 to 56 percent in 2006.

2. Women's productivity has increased with greater investments in human capital. Productivity increases have raised women's wages and increased the opportunity cost of staying home.

3. Reduced birthrates, growth in industries typically attracting women workers, urban migration, increased availability of part-time jobs, and antidiscrimination laws have all increased labor market access for women.

4. in the US during the recession of 2009 the number of women working SURPASSED the number of men for the first time
http://www.nytimes.com/2009/02/06/business/worldbusiness/06iht-06women.19978672.html

  • How do the restrictions placed on the role of women in some countries affect their rate of economic growth and their living standards?

VIII. The Recent Productivity Acceleration

Figure 8.5 Growth of labor productivity in the US, 1973-2007

 

A. Improvement in standard of living is linked to labor productivity - output per worker per hour

B. The U.S. is experiencing a resurgence of productivity growth

  • based on innovations in computers and communications
  • coupled with global capitalism.

 

  • Since 1995 productivity growth has averaged 2.9% annually - up from 1.4% over 1973-95 period.
  • The "Rule of 70" projects real income will double in 24 years rather than 50 years. (Figure 8.5).

    Note: again the authors point out the important role of structural adjustment when they say "coupled with global capitalism"

 

C. Reasons for the Productivity Acceleration since the mid-1990s:
(Much of the recent improvement in productivity is due to "new economy" factors)

1. Microchips and information technology

2. New firms and increasing returns characterize the new economy.

  • Some of today's most successful firms didn't exist 25 years ago: Dell, Compaq, Microsoft, Oracle, Cisco Systems, America Online, Yahoo and Amazon.com are just a few of many.

3. Economies of scale and increasing returns in new firms encourage rapid growth

  • Economies of scale mean that as business get larger their average costs of product (cost per unit produced) decreases. (The long run aver total cost curve [from microeconomics] is downward sloping
    • This means that they can produce each unit of output with fewer rescues
    • Graph showing economies of scale over a wide rage of output

  • Sources of increasing returns and economies of scale include:
    • a. More specialized inputs.

      b. Ability to spread development costs over large output quantities since marginal costs are low.

      c. Simultaneous consumption by many customers at the same time.

      d. Network effects make widespread use of information goods more valuable as more use the products.

      e. Learning increases with practice.

  • What is "simultaneous consumption?
  • What are "network effects"?
  • Note that simultaneous consumption and network effects are relatively recent phenomena

 

4. Global competition encourages innovation and efficiency.

  • another recent phenomenon

D. Even if average growth rates in productivity and real output growth remain higher over time, business cycle fluctuations (i.e. recessions) can still occur. (like 2009)

E. Will it continue?

  • Skepticism about long-term continued growth remains
  • only time will tell.

 

IX. Is Growth Desirable and Sustainable?

A. An antigrowth view exists. (Growth is bad)
1. Growth causes pollution, global warming, ozone depletion, and other problems.

2. "More" is not always better if it means dead-end jobs, burnout, and alienation from one's job.

3. High growth creates high stress.

B. Others argue in defense of growth. (Growth is good)

1. Growth leads to an improved standard of living.

2. Growth helps to reduce poverty in poor countries.

3. Growth has improved working conditions.

4. Growth allows more leisure and less alienation from work.

5. Environmental concerns are important, but growth actually has allowed more sensitivity to environmental concerns and the ability to deal with them.

C. Is growth sustainable? Yes, say proponents of growth.

1. Resource prices are not rising.

2. Growth today has more to do with expansion and application of knowledge and information, so is limited only by human imagination.\]

Note: what about global climate change?

X. LAST WORD: Economic Growth in China

A. China has been experiencing a period of remarkable economic growth.
1. China's real output has grown over the past 25 years at a rate of nearly 9 percent per year, quadrupling real output over that period.

2. Rising income has led to more saving, greater capital investment, and more direct foreign investment, which has helped fuel growth.

3. Per capita income has increased at an annual rate of 8 percent since 1980, despite China's population expanding by 14 million people per year.

4. Increased use of capital, better technology, labor reallocation from agriculture, and increased privatization have all contributed to greater productivity.

5. China's growth has been supported by a dramatic increase in exports ($5 billion in 1978 to $1.2 trillion in 2007).

 

B. Despite its success, China faces a number of important problems:

1. Inflation rates have been high at times (15 to 25 percent per year) because of too much spending relative to capacity. Central banking reform has helped keep inflation low in recent years.

2. State owned enterprises and banks operate unprofitably, likely necessitating a government bailout.

3. China has a poor record of protecting intellectual property rights, and keeps its currency artificially undervalued. These issues have caused tension with the United States and threaten to disrupt trade if they are not resolved.

4. China's growth and development has been uneven, meaning that there are many that have not benefited from the nation's rising incomes.

 

REVIEW

1. State two (three) definitions of economic growth.

2. Suppose an economy's real GDP is $50,000 in year 1 and $55,000 in year 2.

a. What is the growth rate of its GDP?

b. Assume that population was 100 in year 1 and 105 in year 2. What is the growth rate in GDP per capita?

3. Explain why even small changes in the rate of economic growth are significant. Use the "rule of 70" to demonstrate the point.

4. Which is more important — increasing inputs of resources or increasing the productivity of those inputs — as the main source of economic growth in the United States? Explain.

ANSWERS:

1. State two (three) definitions of economic growth.

Economic growth can first be defined and measured as an increase in real GDP occurring over a period of time. This could be caused by an increase in the potential GDP or simply achieving the potential GDP

Economic growth can also be defined and measured as an increase in real GDP per capita occurring over a period of time. Economic growth is usually calculated as an annual percentage rate of growth.

2. Suppose an economy's real GDP is $50,000 in year 1 and $55,000 in year 2.

a. What is the growth rate of its GDP?

b. Assume that population was 100 in year 1 and 105 in year 2. What is the growth rate in GDP per capita?

a. $5,000/$50,000 or 10% in year 1.

b. The per capita growth can be calculated as follows:

  • $500 per capita in year 1 ($50,000/100);
  • $523.81 per capita in year 2 ($55,000/105).
  • The change is 23.81 compared to base of $500 or 23.81/500 = 4.77%.

 

3. Explain why even small changes in the rate of economic growth are significant. Use the "rule of 70" to demonstrate the point.

Small changes in the rate of growth can be very meaningful, especially for a country where a fraction of a percent change in the growth rate may mean the difference between starvation and hunger. Over a period of time small changes are cumulative in the same way that compound interest payments are cumulative on a bank account. Using the rule of 70 to estimate the time it takes to double GDP, we can see that a country whose growth rate is 5% takes 14 years to double its GDP, but a country whose growth rate is 3% may take nearly 10 years longer to double its GDP or about 23.3 years. If these countries continued to grow at their respective 5% and 3% rates, in 28 years the first country's GDP would be quadrupled, whereas in the second country, it would take nearly 47 years to quadruple its GDP from the current year.

4. Which is more important — increasing inputs of resources or increasing the productivity of those inputs — as the main source of economic growth in the United States? Explain.

Both resource quantity and resource productivity contribute significantly to increased economic growth in the United States. About a third of the increase in economic growth comes from increases in resource input and about two-thirds from increases in resource productivity. Clearly, it is not the quantity of resources that is most important but the quality of resources and how they are used for production.