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Economic Growth

9. Economic Growth. CHECKPOINTS. Checkpoint 9.1. Checkpoint 9.3. Checkpoint 9.4. Problem 1. Clicker version. Problem 1. Problem 1. Clicker version. Problem 2. Clicker version. Problem 2. Problem 2. Clicker version. Problem 3. Problem 3. Clicker version. Problem 3. Clicker

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Economic Growth

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  1. 9 Economic Growth CHECKPOINTS

  2. Checkpoint 9.1 Checkpoint 9.3 Checkpoint 9.4 Problem 1 Clicker version Problem 1 Problem 1 Clicker version Problem 2 Clicker version Problem 2 Problem 2 Clicker version Problem 3 Problem 3 Clicker version Problem 3 Clicker version Problem 4 Problem 4 Clicker version Problem 4 Clicker version Checkpoint 9.2 Problem 5 Problem 5 Problem 1 Problem 6 Problem 2 Problem 3

  3. Practice Problem 1 Mexico’s real GDP was 1,448 billion pesos in 1998 and 1,501 billion pesos in 1999. Mexico’s population growth rate in 1999 was 1.8 percent. Calculate Mexico’s economic growth rate in 1999 and the growth rate of real GDP per person in Mexico in 1999. CHECKPOINT 9.1

  4. Solution The economic growth rate equals the percentage change in real GDP: [(Real GDP in 1999 – Real GDP in 1998) ÷ Real GDP in 1998] x 100. When we substitute the numbers, Mexico’s economic growth rate equals [(1,501 billion – 1,448 billion) ÷ 1,448] x 100. Mexico’s economic growth rate in 1999 was 3.7 percent. CHECKPOINT 9.1

  5. Growth rate of real GDP per person equals the growth rate of real GDP minus the population growth rate. When we substitute the numbers, Growth rate of real GDP per person = (3.7– 1.8) percent, which is 1.9 percent. The growth rate of real GDP per person in Mexico in 1999 was 1.9 percent. CHECKPOINT 9.1

  6. Practice Problem 2 Calculate the approximate number of years it will take for real GDP per person to double if an economy maintains an economic growth rate of 12 percent a year and a population growth rate of 2 percent a year. CHECKPOINT 9.1

  7. Solution The growth rate of real GDP per person equals the economic growth rate minus the population growth rate. Real GDP per person grows at (12 – 2) percent a year, which is 10 percent a year. The Rule of 70 tells us that the level of a variable that grows at 10 percent a year will double in 70 ÷ 10 years, or 7 years, if the growth rates are maintained. It will take 7 years for real GDP per person to double. CHECKPOINT 9.1

  8. Practice Problem 3 Calculate the change in the number of years it will take for real GDP per person in India to double if real GDP per person increases from 8 percent a year to 10 percent a year. CHECKPOINT 9.1

  9. Solution The Rule of 70 tells us that a variable that grows at 8 percent a year will double in 70 ÷ 8 years, which is approximately 9 years. By increasing its growth rate to 10 percent a year, the variable will double in 7 years. Real GDP per person in India will two years earlier. CHECKPOINT 9.1

  10. Practice Problem 4 China’s economy picks up speed China’s trend growth rate of real GDP per person was 2.2 percent per year before 1980 and 8.7 percent per year after 1980. In the 12 months to August 2009, China’s output increased by 11.3 percent. Source: World Economic Outlook and FT.com, September 14, 2009 Distinguish between a rise in China’s economic growth rate and a temporary cyclical expansion. How long, at the current growth rate, will it take for China to double its real GDP per person? CHECKPOINT 9.1

  11. Solution Because the pace of growth was maintained over decades, the increase from 2.2 percent a year before 1980 to 8.7 percent a year after 1980 is a rise in China’s economic growth rate. The 11.3 percent increase in 2009 is a temporary cyclical expansion. At the current trend growth rate of 8.7 percent a year, China’s real GDP per person will double in 8 years (70 ÷ 8.7). CHECKPOINT 9.1

  12. Practice Problem 1 The table provides some data for an economy in 2009 and 2010. Calculate the growth rate of real GDP in 2010. CHECKPOINT 9.2

  13. Solution Growth rate of real GDP in 2010 equals (Real GDP in 2010 – Real GDP in 2009) ÷ Real GDP in 2009 x 100 = ($1,050 – $1,000) ÷ $1,000) x 100 = 5 percent. CHECKPOINT 9.2

  14. Practice Problem 2 The table provides some data for an economy in 2009 and 2010. Calculate the labor productivity in 2009 and 2010. Calculate the growth rate of labor productivity in 2010. CHECKPOINT 9.2

  15. Solution Labor productivity equals real GDP per hour of labor. In 2006, labor productivity = $1,000 ÷ 25 = $40.00 an hour. In 2007, labor productivity = $1,050 ÷ 9.6 = $41.05 an hour. Labor productivity growth rate = (41.05 – 40.00) ÷ 40.00 x 100 = 3.75 percent. CHECKPOINT 9.2

  16. Practice Problem 3 Labor productivity on the rise The BLS reported the following data for the year to June 2009: In the nonfarm sector, output fell 5.5 percent as labor productivity increased 1.9 percent—the largest increase since 2003—but in the manufacturing sector, output fell 9.8 percent as labor productivity increased by 4.9 percent—the largest increase since the first quarter of 2005. Source: bls.gov/news.release In both sectors, output fell while labor productivity increased. Did the quantity of labor (aggregate hours) increase or decrease? In which sector was the change in the quantity of labor larger? CHECKPOINT 9.2

  17. Solution Output = Aggregate hours × Labor productivity. In each sector, output decreased and labor productivity increased, so aggregate hours must have decreased. In the manufacturing sector, output fell by a larger percentage and labor productivity increased by a larger percentage than in the nonfarm sector. So aggregate hours must have fallen by a larger percentage in the manufacturing sector. CHECKPOINT 9.2

  18. Practice Problem 1 What does classical growth theory say will eventually end economic growth? CHECKPOINT 9.3

  19. Solution Classical growth theory predicts that when the real wage rate exceeds the subsistence real wage rate, the population grows. With an increasing population, the supply of labor increases, the real wage rate falls and is pulled back toward subsistence level. Real GDP increases, but real GDP per person decreases. CHECKPOINT 9.3

  20. Study Plan Problem What does classical growth theory say will eventually end economic growth? A. A Malthusian population explosion that cannot be sustained. B. Corruption and other abuses by people in government. C. A falling real interest rate. D. The emergence of lasting peace. E. A Malthusian pandemic. CHECKPOINT 9.3

  21. Practice Problem 2 What does neoclassical growth theory say about the source of persistent growth in real GDP per person? CHECKPOINT 9.3

  22. Solution Neoclassical growth theory says that technological advance is the source of persistent growth in real GDP per person. CHECKPOINT 9.3

  23. Study Plan Problem What does neoclassical growth theory say is necessary for real GDP per person to grow persistently? A. The population must stop growing. B. All countries must adopt the same technologies. C. Saving and investment are independent of the rate of technological advance. D. Capital per person must grow at the same rate as real GDP per person. E. Technology must keep advancing. CHECKPOINT 9.3

  24. Practice Problem 3 What does neoclassical growth theory say is the process that will bring the growth of real GDP per person to a stop? CHECKPOINT 9.3

  25. Solution If technology stops advancing, real GDP growth slows because capital accumulation brings diminishing returns. With real GDP growth slowing, saving and investment fall and the growth rate of capital decreases to the population growth rate. Real GDP per person stops growing. CHECKPOINT 9.3

  26. Study Plan Problem According to neoclassical growth theory, the growth of real GDP per person will come to a stop when _______. A. population growth speeds up B. technology stops advancing and capital accumulation brings diminishing returns, which reduces saving and investment C. capital is substituted for labor D. income increases, people consume more and saving dries up CHECKPOINT 9.3

  27. Practice Problem 4 What is the driving force of economic growth according to new growth theory? CHECKPOINT 9.3

  28. Solution The driving force of economic growth according to new growth theory is a persistent incentive to innovate and an absence of diminishing returns. CHECKPOINT 9.3

  29. Study Plan Problem What is the driving force of economic growth according to new growth theory? A. Advancements in medical research. B. The pursuit of leisure. C. Religion D. Productive activities that can be replicated with no diminishing returns. E. Foreign investment. CHECKPOINT 9.3

  30. Practice Problem 5 The productivity watch Former Federal Reserve chairman Alan Greenspan attributes the growth of labor productivity to IT investments that boosted labor productivity, which boosted company profits, which led to more IT investments, and so on, leading to a nirvana of high growth. Source: Fortune Magazine, September 4, 2006 Which of the growth theories that you’ve studied in this chapter best corresponds to the explanation given by Mr. Greenspan? CHECKPOINT 9.3

  31. Solution Mr. Greenspan is describing the new growth theory. According to this theory, the endless pursuit of profit leads to innovations (IT innovations in the period described here) that increase labor productivity, shift the production function upward, increase the demand for labor, raise the real wage rate, and increase profit. The perpetual pursuit of profit will bring persistent economic growth. CHECKPOINT 9.3

  32. Practice Problem 1 What are the preconditions for economic growth? CHECKPOINT 9.4

  33. Solution The preconditions for economic growth are economic freedom, private property rights, and markets. Without these preconditions, people have little incentive to undertake the actions that lead to economic growth. CHECKPOINT 9.4

  34. Study Plan Problem What are the preconditions for economic growth? A. Entrepreneurial spirit and low unemployment. B. A large standing army and small government. C. A small government and property rights. D. Low unemployment and a large standing army. E. Economic freedom, private property rights, and markets. CHECKPOINT 9.4

  35. Practice Problem 2 Why does much of Africa experience slow economic growth? CHECKPOINT 9.4

  36. Solution Some African countries experience slow economic growth because they lack economic freedom, private property rights are not enforced, and markets do not function well. People in these countries have little incentive to specialize and trade or to accumulate both physical and human capital. CHECKPOINT 9.4

  37. Study Plan Problem Why does much of Africa experience slow economic growth? A. It lacks motivation to grow. B. It lacks aid from developed countries. C. It lacks natural resources and labor. D. It lacks economic freedom, private property rights that are enforced, and markets that function well. E. It lacks UN assistance. CHECKPOINT 9.4

  38. Practice Problem 3 Why is economic freedom crucial for achieving economic growth? CHECKPOINT 9.4

  39. Solution Economic freedom is crucial for achieving economic growth because economic freedom allows people to make choices and gives them the incentives to pursue growth-producing activities. CHECKPOINT 9.4

  40. Study Plan Problem Why is economic freedom crucial for economic growth? A. It gives the incentive to save, invest, expand human capital, and discover and apply new technologies. B. It protects workers’ rights and prevents unfair firing. C. It upholds democracy, which is essential if an economy is to grow. D. Only good government can make the right investment decisions. E. It ensures that the majority of citizens make the most important decisions. CHECKPOINT 9.4

  41. Practice Problem 4 What role do property rights play in encouraging economic growth? CHECKPOINT 9.4

  42. Solution Clearly defined property rights and a legal system to enforce them give people the incentives to work, save, invest, and accumulate human capital. CHECKPOINT 9.4

  43. Study Plan Problem What role do property rights play in encouraging economic growth? A. They increase the penalty for theft. B. The give governments the power to acquire property in the public interest. C. They create more equality of income. D. They strengthen the incentive to work, save, invest, and accumulate human capital. E. They ensure that debts are always paid. CHECKPOINT 9.4

  44. Practice Problem 5 Explain why, other things remaining the same, a country with a well-educated population has a faster economic growth rate than a country that has a poorly educated population. CHECKPOINT 9.4

  45. Solution A well-educated population has more skills and a greater labor productivity than a poorly educated population. A well-educated population can contribute to the research and development that create new technology. CHECKPOINT 9.4

  46. Practice Problem 6 India’s economy hits the wall Just six months ago, the Indian economy was growing rapidly; now growth has halted. India needs to spend $500 billion upgrading its infrastructure and education and health-care facilities. Agriculture remains unproductive; and reforms, like strengthening the legal system, have been ignored. Source: BusinessWeek, July 1, 2008 Explain how the measures reported in the news clip could lead to faster economic growth in India. CHECKPOINT 9.4

  47. Solution Investment in infrastructure and education and heath-care facilities would increase India’s stock of physical capital, which would increase labor productivity. Better education and heath care would increase human capital and again increase labor productivity. With better technology and more capital used on farms, productivity of farm workers would increase. Strengthening the legal system could better enforce property rights. These measure could lead to faster growth in labor productivity and faster growth in real GDP per person. CHECKPOINT 9.4

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