Macroeconomic Goal: Economic Growth

Introduction

Review: What do we already know about Economic Growth?

Economic Growth from the 5Es lesson:

Economic Growth is one of the "5 Es" of economics or one of the five ways for a society to reduce scarcity.

We defined Economic Growth as an increase in the ABILITY to produce goods and services and we noted that this not the way the term is normally defined.

This type of Economic Growth is caused by:

a) more resources
b) better resources
c) better technology

If we only had more resources we could produce more goods and services and satisfy more of our wants. This will reduce scarcity and give us more satisfaction (more good and services). All societies therefore try to achieve economic growth.

In the AS-AD chapter we redefined this type of growth as "increasing the potential" level of output.

Economic Growth from Production Possibilities lesson

We used the production possibilities model to demonstrate how economic growth can reduce scarcity.

We can increase our ABILITY to produce goods and services (or increase our POTENTIAL GDP) if we get:

  1. more resources
  2. better resources, and
  3. better technology

Since this increase maximum output that we are able to produce it shifts the production possibilities curve outward. On the graph below, economic growth would cause the production possibilities curve to move from PP1 to PP2.

If we have more resources we are able to produce more and therefore the maximum amount that can be produced (i.e. the production possibilities curve) increases.

This doesn't necessarily mean that the economy IS producing more, just that it CAN produce more. To achieve our new potential levels of output we also need full employment and productive efficiency. It could be possible to have this type of economic growth so that we CAN produce the quantities represented by point E, but if there is unemployment and productive inefficiency we would be at a point beneath this new curve (maybe point C). So we may get new resources or new technology so we CAN produce more (point E on PP2), but if we don't use the new resources (i.e. we have unemployment) or if we don't use the new technology (i.e. we have productive inefficiency) , we may remain on PP1 (point C).

Economic Growth from the AS - AD Lesson:

In the chapter on AS-AD we introduced three different definitions of economic growth:
  1. INCREASING OUR POTENTIAL OUTPUT
  2. Increasing Output (ACHIEVING OUR POTENTIAL), and
  3. Increasing Real GDP per capita

(1) INCREASING OUR POTENTIAL OUTPUT

This is increasing our ABILITY to produce. This is the definition we used in the 5 Es lesson. This is the most fundamental definition of economic growth. It is the type of economic growth used on our 5 Es diagram.

We can increase our ABILITY to produce goods and services (or increase our POTENTIAL GDP) if we get:

  1. more resources
  2. better resources, and
  3. better technology

Since this increases maximum output that we are able to produce it shifts the PPF outward. On the graph below, economic growth would cause the PPF to move from PP1 to PP2.

This doesn't necessarily mean that the economy IS producing more, just that it CAN produce more. To achieve our new potential levels of output we also need full employment and productive efficiency. It could be possible to have this type of economic growth so that we CAN produce the quantities represented by point E, but if there is unemployment and productive inefficiency we would be at a point beneath this new curve (maybe point C). So we may get new resources or new technology so we CAN produce more (point E on PP2), but if we don't use the new resources (i.e. we have unemployment) or if we don't use the new technology (i.e. we have productive inefficiency) , we may remain on PP1 (point C).

In the AS-AD model INCREASING OUR POTENTIAL OUTPUT is represented by in increase in AS.

Notice that when AS increases, the full employment level of output increase from RDO-FE1 to RDO-FE2. This is an increase in our potential level of output.

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.

(2) Increasing Output (or ACHIEVING OUR POTENTIAL)

The most commonly used definition of economic growth is simply increasing output or producing more. (Later we will call this INCREASING REAL GDP.) This is the type of economic growth most often mentioned in news reports like http://money.cnn.com/2009/10/29/news/economy/gdp/index.htm

When an economy increases its output it is often said to have achieved economic growth. But if by producing more we are simply ACHIEVING OUR POTENTIAL, then we could also say that it is REDUCING UNEMPLOYMENT or ACHIEVING PRODUCTIVE EFFICIENCY. On our graph this would be represented by moving from point D to a point on the curve (A, B, or C).

On our AD-AS model we could illustrate this type of growth (producing more) by an increase in AD.

Notice that output increase from RDO-EQUIL to RDO', but the full employment level of output, which is our potential level of output, does not change (RDO-FE).

 

If AD increases enough so that the new equilibrium is at the full employment level of output, it is analogous to going from a point inside the production possibilities curve to a point on the curve.

 

(3) Increasing Real GDP per capita

A third definition of economic growth is an increase in real GDP per capita, or per person. We'll discuss this later.

 

Economic Growth: Three Definitions - REVIEW

1. Increasing our ABILITY to Produce (INCREASING OUR POTENTIAL)

a. "economic growth" on the 5Es chart
b. shifting out to a new production possibilities curve
c. ­AS
d. causes:
(1) change in input prices (more resources)
(2) changes in the productivity of resource (better res., better tech.)
(3). legal-institutional environment

2. Increasing output or increasing Real GDP (ACHIEVING OUR POTENTIAL)

a. achieving "full employment" and "productive efficiency" (5Es)
b. going from a point inside the PPC to a point closer to the PPC
c. ­AD
d. increasing GDP per capita
e. causes:
(1) producing at a minimum cost to achieve productive efficiency
(a) not using more resources than necessary
(b) using resources where they are best suited
(c) Using the appropriate technology

(2) more spending to ­ AD and achieve full employment

(a) ­C
(b) ­ I
(c) ­ G
(d) ­ Xn

3. ­ GDP per capita: ­ real GDP at a faster rate than the increase in the population

Chapter 8 - Economic Growth

I am going to do things differently in this online lecture. Below is a detailed outline of the textbook. You can use it to guide your reading an for taking notes from the reading. I will add my own notes.

I. Introduction

A. Learning objectives - After completing this chapter the student should be able to:
  1. Define two measures of economic growth.
  2. Explain why growth is a desirable goal.
  3. Understand the institutional structure an economy needs if it is to experience "modern economic growth" and ongoing increases in standards of living.
  4. Identify two main sources of growth.
  5. Explain and apply the "rule of 70."
  6. Give average long-term growth rates for U.S. and qualifications of raw data.
  7. Show economic growth using production possibilities analysis and aggregate demand aggregate supply analysis.
  8. Describe the growth record of the U.S. economy since 1950, including two measures of its long term growth rates.
  9. Identify six major factors that contributed to U.S. economic growth according to empirical studies.
  10. List three primary reasons for productivity acceleration in the United States since 1995.
  11. List five reasons for increasing returns during the period of productivity acceleration.
  12. Evaluate the potential for the productivity acceleration to be a permanent phenomenon.
  13. Identify and explain the arguments for and against economic growth.
  14. Define and identify terms and concepts at the end of the chapter.

 

II. Economic Growth.

A. Two definitions of economics growth are given.
1. The increase in real GDP, which occurs over a period of time. Here the author does not make a distinction between and increase in the potential GDP and achieving the potential GDP. Both of these could cause an "increase in real GDP.

2. The increase in real GDP per capita, which occurs over time. This definition is superior if comparison of living standards is desired. For example, China's 2003 GDP was $1410 billion compared to Denmark's $212 billion, but per capita GDP's were $1110 and $33,750 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. 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.

C. 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 absolute value of a 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"

D. 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 sixfold 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 3.4 percent per year since 1950 and real GDP per capita has grown about 2.1 percent per year. But the arithmetic needs to be qualified.

III. 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 is 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
  • is well is 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"?
  • 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 2004 so much higher than that of other rich countries?

4. CONSIDER THIS … Economic Growth Rates Matter

"Even small differences in growth rates matter!"

IV. 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)

b. Compounding makes seemingly small differences in growth rates quite significant.

c. Over a 70-year period, a 4 percent growth rate will generate twice is much output is a 3 percent growth rate, and nearly four times is much income is a 2 percent growth rate.

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

V. Ingredients of Growth

A. Four supply factors relate to the ability to grow. [Shift the production possibilities outward from AB to DC in Figure 8.2 below]
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.

B. Two demand and efficiency factors are also related to growth. [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.]

1. Aggregate demand must increase for production to expand.

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

 

VI. Production Possibilities Analysis (Figure 8.2)

Figure 8.2

A. Growth can be illustrated with a production possibilities curve (Figure 8.2), where growth is indicated is an outward shift of the curve from AB to CD.

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

2. Additional resources that shift the curve outward must be employed fully and efficiently (productive efficiency) to make the maximum possible contribution to domestic output.

3. For the economy to achieve the maximum increase in value, the optimal combination of goods must be achieved (allocative efficiency).

Note: it may be useful to reread the 5Es lecture so that you are sure to know the difference between productive efficiency and allocative efficiency. [http://www.harpercollege.edu/mhealy/eco212i/lectures/ch1-18.htm]

VII. Accounting for growth is an attempt to quantify factors contributing to economic growth.

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 and 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.

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

 

C. 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), BUT WHAT CAUSED THE INCREASE IN PRODUCTIVITY?

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 is the size of markets and firms that serve them have grown.

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

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

 

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 resources (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

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"

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

C. Much of the recent improvement in productivity is due to "new economy" factors such is:

Reasons for the Productivity Acceleration since the mid-1990s:

1. Microchips and information technology are the basis for improved productivity. Many new inventions are based on microchip technology.

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

a. 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.

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

Economies of scale mean that is 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 resources

Graph showing economies of scale over a wide rage of output

3. 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 is 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. Skepticism about long-term continued growth remains, and 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.