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Economic Growth. Economic Growth. Growth = Annual Growth Rate of p c Income, GDP Growth Rates across the world 65 – 95: “spectaculat”: China (8.2 %) “very good”: East Asia (5.5 %) “decent”: South East Asia “bad”: Latin America “very bad”: Sub Saharan Africa.
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EconomicGrowth • Growth = Annual Growth Rate of p c Income, GDP • Growth Rates across the world 65 – 95: • “spectaculat”: China (8.2 %) • “very good”: East Asia (5.5 %) • “decent”: South East Asia • “bad”: Latin America • “very bad”: Sub Saharan Africa
Modern EconomicGrowth : BasicFeatures • Today a growth rate of 2% is no surprise! • Leaders over past four centuries: • 1580 – 1820: Netherlands 0.2% (real p c GDP growth), • 1820 – 1890: U.K. 1.2 % (annual growth of GDP), • 1890 – 1989: U. S. 2.2 % (average annual growth rate). • With a 2% rate, nation’s pc GDP doubles in 35 years => shorter than a life span!
Theories of EconomicGrowth • Economic growth is the result of abstention from current consumption. • Economy produces variety of products => production generates income => Income buys these commodities produced (depending on distribution of income and preferences).
Circularflow of EconomicActivity investment outflow inflow Firms Wages, Profits, Rents Consumption Expenditure outflow inflow Households savings
TwoGroups of Commodities • Consumption Goods: Produced for the purpose of satisfying human needs and preferences => Households buy • Capital Goods: Produced for the purpose of producing other commodities => Firms buy
Saving - Investment • If all income is paid out to households, and if households spend their income on consumption goods, where doest the market for capital goods come from? • Households save, by abstaining from current consumption, households make available pool of loanable funds that firms use to buy capital goods. • Buying power is channeled from savers to investors through banks, individual loans, governments, and stock markets.
Startingpoint of all of thetheory of EconomicGrowth: • Without the initial availability of savings, it would not be possible to invest and there would be no expansion! • Macroeconomic Balance: • Investment Demand = Savings Leakage
Saving & Investment • Households’ Choice • HouseholdsreceiveincomeY, can eithersaveorconsume, i.e. • Y = C + S • Firms’ Choice • Firmsproduce a set of goodsworth Y, theseareeitherinvestmentorconsumptiongoods, i.e. • Y = C + I • HouseholdsandFirms in a ClosedEconomy • In a closedeconomy, thevalue of savingsequalsthevalue of investment • Y = C + I • Y = C + S => S = I
KEY DEFINITION: Investment • Investment: Change in CapitalStock • I(t)= K(t) – K(t-1) • Intangible vs. Tangibleobjectsthatcontributestoincreasedproduction. • HumanCapital: Act of trainingandeducation • Change in CapitalStockoccursbecause of : • Deliberateactions of firms, i.e. Purchase of newcapitalgoods, sale of oldcapitalgoods • Depreciation, i.e. Naturalwearandtear
Economic Growth is positive when investment exceeds the amount necessary to replace depreciated capital, thereby allowing the next period’s cycle to recur on a larger scale => Economy expands!
TheHarrod – Domar Model -3- Recipe: Growth pc = (savings rate/ capital output ratio) - population growth rate - depreciation
