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Parkin-Bade Chapter 30

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8 CHAPTER Economic Growth After studying this chapter you will be able to Define and calculate the economic growth rate and explain the implications of sustained ... – PowerPoint PPT presentation

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Title: Parkin-Bade Chapter 30


1
8
CHAPTER
Economic Growth
2
After studying this chapter you will be able to
  • Define and calculate the economic growth rate and
    explain the implications of sustained growth
  • Describe the economic growth trends in the United
    States and other countries and regions
  • Identify the main sources of economic growth
  • Explain how we measure the effects of the sources
    of economic growth and identify why growth rates
    fluctuate
  • Explain the main theories of economic growth

3
Transforming Peoples Lives
  • Real GDP per person in the United States almost
    tripled between 1960 and 2005.
  • What causes the growth in production, income, and
    living standards?
  • Elsewhere, notably in China and other parts of
    Asia, growth is even faster and technology 2,000
    years old coexists with the most modern.
  • Why are incomes in Asia growing so fast?

4
The Basics of Economic Growth
  • Economic growth is the sustained expansion of
    production possibilities measured as the increase
    in real GDP over a given period.
  • Calculating Growth Rates
  • The economic growth rate is the annual percentage
    change of real GDP.
  • The economic growth rate tells us how rapidly the
    total economy is expanding.

5
The Basics of Economic Growth
  • The standard of living depends on real GDP per
    person.
  • Real GDP per person is real GDP divided by the
    population.
  • Real GDP per person grows only if real GDP grows
    faster than the population grows.

6
The Basics of Economic Growth
  • The Magic of Sustained Growth
  • The Rule of 70 states that the 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.

7
The Basics of Economic Growth
  • Applying the Rule of 70
  • Figure 8.1 show the doubling time for growth
    rates.
  • A variable that grows at 2 percent a year doubles
    in 35 years.
  • A variable that grows at 7 percent a year doubles
    in 10 years.

8
Economic Growth Trends
  • Growth in the U.S. Economy
  • From 1905 to 2005, growth in real GDP per person
    in the United States averaged 2 percent a year.
  • Real GDP per person fell precipitously during the
    Great Depression and rose rapidly during World
    War II.
  • The growth rate was greater after World War II
    than it was before the Great Depression.
  • Figure 8.2 on the next slide illustrates.

9
Economic Growth Trends
10
Economic Growth Trends
  • Real GDP Growth in the World Economy
  • Figure 8.3(a) shows the growth in the rich
    countries.
  • Japan grew rapidly in the 1960s, slower in the
    1980s, and even slower in the 1990s.
  • Growth in Europe Big 4, Canada, and the United
    States has been similar.

11
Economic Growth Trends
  • Figure 8.3(b) shows the growth of real GDP per
    person in group of poor countries.
  • The gaps between real GDP per person in the
    United States and in these countries have
    widened.

12
Economic Growth Trends
  • Figure 8.4 shows growth in Asian economies.
  • China is growing very rapidly.
  • Other formerly low-income economiesKorea,
    Taiwan, Singapore, and Hong Kong are
    exampleshave grown very rapidly and
  • have caught up or are catching up with the United
    States.

13
The Sources of Economic Growth
  • Real GDP growth contributes to improvements in
    our standard of living.
  • But our standard of living improves only if we
    produce more goods and services.
  • We begin by dividing real GDP growth into the
    forces that increase
  • Aggregate hours
  • Labor productivity

14
The Sources of Economic Growth
  • Aggregate Hours
  • Aggregate hours, the total number of hours worked
    by all the people employed, change as a result
    of
  • 1. Working-age population growth
  • 2. Changes in the employment-to-population ratio
  • 3. Changes in average hours per worker
  • Population growth increases aggregate hours and
    real GDP, but to increase real GDP person, labor
    must become more productive.

15
The Sources of Economic Growth
  • Labor Productivity
  • Labor productivity is the quantity of real GDP
    produced by an hour of labor it equals real GDP
    divided by aggregate hours.
  • The growth of labor productivity depends on
  • Physical capital growth
  • Human capital growth
  • Technological advances

16
The Sources of Economic Growth
  • Physical Capital Growth
  • Physical capital growth results from saving and
    investment decisions.
  • The accumulation of new capital increased capital
    per worker and increased labor productivity.
  • Human Capital Growth
  • Human capital acquired through education,
    on-the-job training, and learning-by-doing is the
    most fundamental source of economic growth.
  • It is the source of increased labor productivity
    and technological advance.

17
The Sources of Economic Growth
  • Technological Advances
  • Technological changethe discovery and the
    application of new technologies and new goodshas
    contributed immensely to increasing labor
    productivity.
  • Figure 8.5 on the next slide summarizes the
    process of growth.
  • It also shows that the growth of real GDP per
    person depends on real GDP growth and the
    population growth rate.

18
The Sources of Economic Growth
19
The Sources of Economic Growth
  • Preconditions for Economic Growth
  • The basic precondition for economic growth is an
    appropriate incentive system.
  • Three institutions are crucial to the creation of
    the proper incentives
  • 1. Markets
  • 2. Property rights
  • 3. Monetary exchange

20
Growth Accounting
  • 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.
  • The purpose of growth accounting is to calculate
    how much real GDP growth results from the growth
    of labor and capital and how much is attributable
    to technological change.

21
Growth Accounting
  • The identify the contribution of capital growth
    to real GDP growth, we need to know labor
    productivity changes when the quantity of capital
    changes.
  • The law of diminishing returns states
  • As the quantity of one input (capital) increases
    with the quantities of all other inputs (labor
    hours and technology) remaining the same, output
    increases but in ever smaller increments.
  • But how much smaller are the increments?
  • The answer is given by the one third rule.

22
Growth Accounting
  • Robert Solow discovered that diminishing returns
    are well described by the one-third rule
  • With no change in technology, on the average, a 1
    percent increase in capital per hour of labor
    brings a 1/3 percent increase in labor
    productivity (real GDP per hour of labor).
  • For example, suppose capital per hour of labor
    grows by 3 percent and labor productivity grows
    by 2.5 percent.
  • The one third rule tells us that capital growth
    contributed 1/3 of 3 percent, which is 1 percent,
    to labor productivity growth.
  • Human capital growth and technological change
    contributed the other 1.5 percent.

23
Growth Accounting
  • Accounting for the Productivity Growth Slowdown
    and Speedup
  • We can use the one third rule to study
    productivity growth in the United States.
  • Figure 8.6 on the next slide illustrates.

24
Growth Accounting
  • Part (a) shows the growth of U.S. labor
    productivity.
  • Booming Sixties
  • Between 1960 and 1973, labor productivity grew by
    3.7 percent a year.
  • Capital growth (green bar) and technological
    change and growth of human capital (purple bar)
    contributed equally to this growth.

25
Growth Accounting
  • Slowdown
  • Between 1973 and 1983, labor productivity slowed
    to 1.7 percent a year.
  • A collapse in the contribution of technological
    change and human capital (purple bar) brought
    about this slowdown in the growth of labor
    productivity.

26
Growth Accounting
  • Speedup
  • Labor productivity growth rate increased to 2
    percent a year between 1983 and 1993 and to 2.4
    percent between 1993 and 2005.
  • Technological change and growth of human capital
    contributed most to this speedup in the growth of
    labor productivity.

27
Growth Accounting
  • Achieving Faster Growth
  • To achieve faster economic growth we must either
    increase the growth of capital per hour of labor
    or increase the pace of technological change.
  • The main suggestions for achieving these
    objectives are
  • Stimulate saving
  • Stimulate research and development
  • Target high-technology industries
  • Encourage international trade
  • Improve the quantity of education

28
Growth Accounting
  • Stimulate Saving
  • Saving finances investment. So higher saving
    rates might increase physical capital growth.
  • Tax incentives might be provided to boost saving.

29
Growth Accounting
  • 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.
  • So the market might allocate too few resources to
    research and development.
  • Government subsidies and direct funding might
    stimulate basic research and development.

30
Growth Accounting
  • Target High-Technology Firms
  • The suggestion is that by subsidizing
    high-technology industries, a nation can enjoy a
    temporary advantage over its competitors.
  • This is a very risky strategy because it is
    unclear that government is better at picking
    winners than the profit-seeking entrepreneurs.

31
Growth Accounting
  • Encourage International Trade
  • Free international trade stimulates growth by
    extracting all the available gains from
    specialization and trade.
  • The fastest growing nations are the ones with the
    fastest growing exports and imports.
  • Improve the Quality of Education
  • The benefits from education spread beyond the
    person being educated, so there is a tendency to
    under invest in education.

32
Growth Theories
  • Real GDP increases if
  • 1. The economy recovers from a recession.
  • 2. Potential GDP increases.
  • Economic growth is the sustained increase in
    potential GDP.
  • Two factors that increase potential GDP are
  • An increase in labor productivity
  • An increase in population

33
Growth Theories
  • An Increase in Labor Productivity
  • Three factors increase labor productivity
  • An increase in physical capital
  • An increase in human capital
  • An advance in technology
  • An increase in labor productivity shifts the
    production function upward and increases the
    demand for labor.
  • The equilibrium real wage rate, quantity of
    labor, and potential GDP all increase.

34
Growth Theories
  • Figure 8.7(a) shows the change in potential GDP.
  • The increase in labor productivity shifts the
    production function upward.

35
Growth Theories
  • Figure 8.7(b) illustrates these effects in the
    labor market.
  • An increase in labor productivity increases the
    demand for labor.
  • With no change in the supply of labor, the real
    wage rate rises
  • and aggregate hours increase.

36
Growth Theories
  • And with the increase in aggregate hours,
    potential GDP increases.

37
Growth Theories
  • An Increase in Population
  • An increase in population increases the supply of
    labor.
  • With no change in the demand for labor, the
    equilibrium real wage rate falls and the
    aggregate hours increase.
  • The increase in the aggregate hours increases
    potential GDP.

38
Growth Theories
  • Figure 8.8(a) illustrates these effects in the
    labor market.
  • The labor supply curve shifts rightward.
  • The real wage rate falls
  • and aggregate hours increase.

39
Growth Theories
  • The increase in aggregate hours increases
    potential GDP.
  • Because the marginal product of labor diminishes,
    the increased population increases real GDP but
    decreases real GDP per hour of labor.

40
Growth Theories
  • We study three growth theories
  • Classical growth theory
  • Neoclassical growth theory
  • New growth theory
  • Classical Growth Theory
  • Classical growth theory is the view that the
    growth of real GDP per person is temporary and
    that when it rises above the subsistence level, a
    population explosion eventually brings real GDP
    per person back to the subsistence level.

41
Growth Theories
  • Classical Theory of Population Growth
  • There is a subsistence real wage rate, which is
    the minimum real wage rate needed to maintain
    life.
  • Advances in technology lead to investment in new
    capital.
  • Labor productivity increases and the real wage
    rate rises above the subsistence level.
  • When the real wage rate is above the subsistence
    level, the population grows.
  • Population growth increases the supply of labor
    and brings diminishing returns to labor.

42
Growth Theories
  • As the population increases the real wage rate
    falls.
  • The population continues to grow until the real
    wage rate has been driven back to the subsistence
    real wage rate.
  • At this real wage rate, both population growth
    and economic growth stop.
  • Contrary to the assumption of the classical
    theory, the historical evidence is that
    population growth rate is not tightly linked to
    income per person, and population growth does not
    drive incomes back down to subsistence levels.

43
Growth Theories
  • Neoclassical Growth Theory
  • Neoclassical growth theory is the proposition
    that 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 stops.

44
Growth Theories
  • The Neoclassical Economics of Population Growth
  • The neoclassical view is that the population
    growth rate is independent of real GDP and the
    real GDP growth rate.
  • Technological Change
  • In the neoclassical theory, the rate of
    technological change influences the economic
    growth rate but economic growth does not
    influence the pace of technological change.
  • It is assumed that technological change results
    from chance.

45
Growth Theories
  • Target Rate of Return and Saving
  • The key assumption in the neoclassical growth
    theory concerns saving.
  • Other things remaining the same, the higher the
    real interest rate, the greater is the amount
    that people save.
  • To decide how much to save, people compare the
    rate of return with a target rate of return.
  • If the rate of return exceeds the target rate of
    return, saving is sufficient to make capital per
    hour of labor grow.

46
Growth Theories
  • If the rate of return is less than the target
    rate of return, saving is not sufficient to
    maintain the current level of capital per hour of
    labor, so capital per hour of labor shrinks.
  • And if the rate of return equals a target rate of
    return, saving is just sufficient to maintain the
    quantity of capital per hour of labor at its
    current level.

47
Growth Theories
  • The Basic Neoclassical Idea
  • Technology begins to advance more rapidly.
  • New profit opportunities arise.
  • Investment and saving increase.
  • As technology advances and the capital stock
    grows, real GDP per person rises.
  • Diminishing returns to capital lower the real
    interest rate and eventually growth stops, unless
    technology keeps on advancing.

48
Growth Theories
  • New Growth Theory
  • New growth theory holds that real GDP per person
    grows because of choices that people make in the
    pursuit of profit and that growth can persist
    indefinitely.
  • The theory begins with two facts about market
    economies
  • In a market economy, discoveries result from
    choices.
  • Discoveries bring profit and competition
    destroys profit.

49
Growth Theories
  • Two further facts play a key role in the new
    growth theory are
  • Discoveries are a public capital good.
  • Knowledge is not subject to diminishing returns.
  • Knowledge Capital Is Not Subject to Diminishing
    Returns
  • Increasing the stock of knowledge makes capital
    and labor more productive. The fact that
    knowledge capital does not experience diminishing
    returns is the central proposition of new growth
    theory.

50
Growth Theories
  • Figure 8.9 summarizes the ideas of new growth
    theory as a perpetual motion machine.

51
THE END
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