Macroeconomic Goal: Economic Growth

Introduction

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

Review: What do we already know about 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.

Let's define Economic Growth as an increase in the ABILITY to produce goods and services. This is not the way the term is normally defined. Later this semester we'll discuss the various definitions of Economic Growth, but here we'll use this more fundamental definition:

Economic Growth is an increase in the ABILITY to produce goods and services.

This means we are ABLE to produce more, but it doesn't necessarily mean we do produce more. More on this later.

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.

From Production Possibilities lesson - Economic Growth

In Macroeconomics we study three main issues:

  1. Unemployment (UE)
  2. Inflation (IN), and
  3. Economic Growth (EG)

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

Our multimedia lesson use several definitions of economic growth. let me review them here.

Three Definitions of Economic Growth

(1) Increasing our POTENTIAL OUTPUT

I like to call this increasing our ABILITY to Produce. this is the definition we used in the 5Es lesson. This is the most fundamental definition of economic growth. It is the type of economic growth used on out 5Es 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 increase 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).

(2) Increasing Output (or ACHIEVING our potential output)

The most commonly used definition of economic growth is simply producing more. (Later we will call this INCREASING REAL GDP.)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).

 

(3) Increasing Real GDP per capita

The definition of economic growth used in our multimedia lesson on economic growth (Macro_015.les) is an increase in GDP per capita. This means increasing output per person. GDP per capita is calculated by dividing output by the population.

From the AS - AD Lesson:

 Economic Growth

What about economic growth? In an earlier lesson we discussed three definitions of economic growth
  1. Increasing our POTENTIAL OUTPUT
  2. Increasing Output, and
  3. Increasing Real GDP per capita

(1) Increasing our POTENTIAL OUTPUT

I like to call this 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 out potential)

The most commonly used definition of economic growth is simply producing more. (Later we will call this INCREASING REAL GDP.)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 increase so that 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

The definition of economic growth used in our multimedia lesson on economic growth (Macro_015.les) is an increase in GDP per capita. This means increasing output per person. GDP per capita is calculated by dividing output by the population. 

Economic Growth: Three Definitions - REVIEW

1. Increasing our ABILITY to Produce (INCREASING potential output)

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 fullemployment

(a) ­C
(b) ­ I
(c) ­ G
(d) ­ Xn

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

Growth Record of the United States (Table 17-5)

A. Real GDP has increased more than sixfold since 1940, and real per capita GDP has risen by a multiple of three.

B. Rate of growth record shows:

1. real GDP has grown 3.1 percent per year since 1948

2. real GDP per capita has grown about 2 percent per year.

C. In last four years of the century, U.S. economic growth surged and averaged more than 4 percent per year. But the arithmetic needs to be qualified.

1. Growth doesn’t measure quality improvements.

2. Growth doesn’t measure increased leisure time.

3. Growth doesn’t take into account adverse effects on environment.

4. International comparisons are useful in evaluating U.S. performance. For example, Japan has grown more than twice as fast as U.S. since 1948 but less in past decade.

Accounting for Growth

Accounting for growth is an attempt to quantify factors contributing to economic growth as shown in Table 17-1. Important research has been done in the area by Edward Denison.

A. Inputs (quantity) vs. Productivity (quality)
1. Quantity of Labor
Labor force has grown about 2 million workers per year for past 25 years and accounts for about one-third of total economic growth.

2. Technological Advance

a. the most important factor
b. estimated to contribute to about 26 percent of the U.S. growth record since 1929.

3. Quantity of Capital
estimated to have contributed 18% to economic growth in U.S. since 1929.

a. role of saving
b. Production Possibilities Curve

4. Education and Training (data)
estimated to have contributed 11% to economic growth in U.S. since 1929.

5. Improved Resource Allocation
contribute to growth and explain about 6% of total.

  • discrimination disappears
  • labor moves where it is most productive
  • tariffs and other trade barriers are lowered.

6. Economies of Scale
contribute to growth and explain about 6% of total.

  • the size of markets and firms that serve them have grown.
  • role of international trade

7. Other Factors
Other factors influence growth and are more difficult to measure.

a. Social-cultural environment and political stability are "growth friendly" in U.S.
  • Respect for material success provides incentive to increase incomes.
  • Market system rewards actions that increase output.
  • Property rights and legal system encourage growth.
    •

    b. Positive attitudes toward work and flow of energetic immigrants also add to growth.

    Productivity Growth and the New Economy (Figure 17-7)

    A. Improvement in standard of living is linked to labor productivity – output per worker per hour.
    1. The U.S. is experiencing a resurgence of productivity growth

    2. based on innovations in computers and communications,

    3. also based on global capitalism.

    4. Since 1995 productivity growth has averaged 2.9% annually – up from 1.4% over 1973-95 period.

    5. "Rule of 70" projects real income will double in 23 years rather than 50 years.

    B. Much recent improvement in productivity is due to "new economy" factors such as:

    1. Microchips and information technology are the basis for improved productivity.

    2. New firms and increasing marginal returns.

    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. (See Table 17-1)

    3. Sources of increasing returns include:

    a. More specialized inputs.

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

    c. Simultaneous consumption of many customers at same time.

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

    e. Learning increases with practice.

    4. Global competition encourages innovation and efficiency.

     

    C. Macroeconomic outcomes

    1. increases in aggregate supply (graph).

    2. Faster growth without inflation is possible with higher productivity. (graph1, graph2)

    3. The natural rate of unemployment seems to be lower (4.5 – 5.0%).

    4. Federal revenues increase with economic growth

    a. 1995 deficit of $160 billion
    b. $167 billion surplus in 2000.

    D. Skepticism about long-term continued growth remains  

    From the Previous Edition of the Textbook:
    The Productivity GROWTH Slowdown

    A. Significance
    1. slower growth in the standard of living
    2. more inflation as AD increases (graph1, graph2)
    3. less competitive on world markets

    B. Causes of the Slowdown

    1. labor quality
    a. decline in experience level
    b. less growth in worker abililities
    c. slowing of increased educational attainment

    2. technological progress slowing
    3. Investment slowing

    a. low saving rate
    b. import competition
    c. regulation
    d. reduced infrastructure spending

    4. energy prices increasing
    5. industrial relations worsening

    Is Growth Desirable?

    A. The Anti-Growth View
    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. In defense of Growth

    1. Growth leads to 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.

    C. Environmental Concerns

    1. Some argue that growth harms the environment

    2. but growth actually has allowed more sensitivity to environmental concerns and the ability to deal with them.

    D. Is growth sustainable?

    1. Yes, say proponents of growth.

    2. Resource prices are not rising.

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

    Some Pleasant Side Effects of the New Economy

    A. Economists Jason Saving and W. Michael Cox point to other benefits of New Economy besides improved living standards.

    B. Crime rates are down possible due to better job and income prospects.

    C. Welfare rolls have fallen from 5.5% of U.S. population in 1995 to 2.5% in 1999.

    D. Charitable contributions increased an average 9% annually, much higher than previous increases in giving.

    E. Minority well being improved with decreased poverty and unemployment rates.