CHAPTER 11 Economic Growth

1. ECONOMICS 5e Michael Parkin CHAPTER 11Economic Growth Chapter 28 in Economics

2. Learning Objectives • Describe the long-term growth trends in the United States and other countries and regions • Identify the main sources of long-term real GDP growth • Explain the productivity growth slowdown in the United States during the 1970s

3. Learning Objectives (cont.) • Explain the rapid economic growth rates being achieved in East Asia • Explain the theories of economic growth

4. Learning Objectives • Describe the long-term growth trends in the United States and other countries and regions • Identify the main sources of long-term real GDP growth • Explain the productivity growth slowdown in the United States during the 1970s

5. Long-Term Growth Trends We are interested in long-term growth primarily because it brings rising incomes per person.

6. A Hundred Years of Economic Growth in the United States

7. Long-Term Growth Trends Real GDP Growth in the World Economy • The United States has the highest real GDP per person, and Canada has the second highest • Europe’s Big 4 (France, Germany, Italy, and the United Kingdom) were the third richest countries until 1985 when Japan caught up to them.

8. Learning Objectives (cont.) • Explain the rapid economic growth rates being achieved in East Asia • Explain the theories of economic growth • Describe the policies that might be used to speed up economic growth

9. Economic Growth Around the World: Catch-Up or Not?

10. Economic Growth Around the World: Catch-Up or Not?

11. Catch-Up Asia

12. Learning Objectives • Describe the long-term growth trends in the United States and other countries and regions • Identify the main sources of long-term real GDP growth • Explain the productivity growth slowdown in the United States during the 1970s

13. The Causes of Economic Growth: A First Look Preconditions for Economic Growth 1) Markets 2) Property rights 3) Monetary exchange

14. The Causes of Economic Growth: A First Look Activities that Generate Ongoing Economic Growth • Saving and Investment in New Capital • Investment in Human Capital • Discovery of New Technologies

15. The Causes of Economic Growth: A First Look Saving and Investment in New Capital New capital increases the capital per worker and increases real GDP per hour of labor — labor productivity.

16. The Causes of Economic Growth: A First Look Investment in Human Capital The accumulated skill and knowledge of human beings is the most fundamental source of economic growth.

17. The Causes of Economic Growth: A First Look Discovery of New Technologies The discovery and the application of new technologies and new goods has increased labor productivity tremendously.

18. Learning Objectives • Describe the long-term growth trends in the United States and other countries and regions • Identify the main sources of long-term real GDP growth • Explain the productivity growth slowdown in the United States during the 1970s

19. Growth Accounting The quantity of real GDP supplied (Y) depends on three factors: 1) The quantity of labor (N) 2) The quantity of capital (K) 3) The state of technology (T)

20. Growth Accounting Growth accounting is used to calculate how much real GDP growth results from growth of labor and capital and how much is attributable to technological change. A key tool is the aggregate production function: Y = F(N,K,T)

21. Growth Accounting Labor Productivity • Labor productivity is real GDP per hour of work. • Equals real GDP divided by aggregate labor hours • Determines how much income an hour of labor generates

22. Real GDP per Hour of Work

23. Growth Accounting Growth accounting divides growth into two components. 1) Growth in capital per hour of labor 2) Technological change Includes everything that contributes to labor productivity growth that is not included in growth in capital per hour

24. Growth Accounting The Productivity Function A relationship that shows how real GDP per hour of labor changes as the amount of capital per hour of labor changes with a given state of technology.

25. Growth Accounting The Productivity Function The shape of the productivity function reflects the law of diminishing returns. The law of diminishing returns states that as the quantity of one input increases with the quantities of all other inputs remaining the same, output increases but by ever smaller increments.

26. PF0 Effect of technological change Effect of increase in capital stock How Productivity Grows 32 PF0 25 Real GDP per hour of work (1992 dollars) 20 0 30 60 Capital per hour of work (1992 dollars)

27. Growth Accounting The Productivity Function • Applying the law of diminishing returns to capital, the law states that if a given number of hours of labor use more capital, the additional output that results from the additional capital gets smaller as the amount of capital increases. • The one third rule explains how much less.

28. Growth Accounting The One Third Rule • Robert Solow of MIT discovered that on average, with no change in technology, a 1 percent increase in capital per hour of labor brings a one third of a 1 percent increase in real GDP per hour of labor.

29. Growth Accounting Accounting for the Productivity Growth Slowdown and Speedup We can use the one third rule to study U.S. productivity growth and the productivity growth slowdown.

30. Growth Accounting Accounting for the Productivity Growth Slowdown and Speedup 1960 to 1973 • The economy grew due to rapid technological changes. • Real GDP per hour expanded by 39 percent. • Capital per hour increased by 24 percent. • With no change in technology, the economy would have expanded by only 8 percent (1/3 of 24 percent).

31. Growth Accounting Accounting for the Productivity Growth Slowdown and Speedup 1973 to 1983 • Predominantly, the reason for the productivity growth slowdown can be attributed to a decline in the rate of technological change. • Real GDP per hour expanded by 8 percent. • Capital per hour increased by 15 percent. • With no change in technology, the economy would have expanded by 5 percent (1/3 of 15 percent).

32. Growth Accounting Accounting for the Productivity Growth Slowdown and Speedup 1983 to 1995 • The economy grew due to more rapid technological change. • Real GDP per hour expanded by 18.5 percent. • Capital per hour increased by 11 percent. • With no change in technology, the economy would have expanded by only 3.7 percent (1/3 of 11 percent).

33. Growth Accounting and the Productivity Growth Slowdown

34. Growth Accounting Technological Change During the Productivity Growth Slowdown Technology was directed toward coping with two major problems. 1) Energy price shocks 2) The environment

35. Growth Accounting Technological Change During the Productivity Growth Slowdown Energy Price Shocks • 1973–1974 and 1979—1980 • Fuel inefficient methods of transportation and production were scrapped at an increased rate • Technological change focused on saving energy rather than enhancing productivity

36. Growth Accounting Technological Change During the Productivity Growth Slowdown The Environment • The 1970s saw an expansion of laws and resources devoted to protecting the environment and improving the quality of the workplace. • These benefits are not included in real GDP.

37. Growth Accounting Achieving Faster Growth • Stimulate Saving • Stimulate high-technology industries • Target high-technology industries • Encourage international trade • Improve the quality of education

38. Learning Objectives (cont.) • Explain the rapid economic growth rates being achieved in East Asia • Explain the theories of economic growth

39. Growth Theory Three theories that attempt to explain what causes economic growth and makes growth rates vary are: 1) Classical Growth Theory 2) Neoclassical Growth Theory 3) New Growth Theory

40. Growth Theory Classical Growth Theory • The view that real GDP growth is temporary and that when real GDP per person rises above the subsistence level a population explosion eventually brings real GDP per person back to the subsistence level. • Thomas Malthus is given most of the credit for the theory, hence the name Malthusian theory.

41. Growth Theory Classical Growth Theory The Basic Idea The world of 1776: Real GDP has increased and the real wage rate has increased. But the classical economists believe that this new situation can’t last because it will induce a population explosion.

42. Growth Theory Classical Growth Theory The modern theory of population growth explains that the population growth is influenced by economic factors.

43. Growth Theory Modern Theory of Population Growth • If there is any relationship between income levels and population growth, it is the opposite of that feared by the classical economists. • In reality, the relationship is weak. • The relation is so weak that it can be said that the rate of population growth is virtually independent of the rate of economic growth.

44. Growth Theory Classical Growth Theory Subsistence real wage rate - to explain the high rate of population growth • The subsistence real wage rate is the minimum real wage rate needed to maintain life. • If the actual real wage rate is less than the subsistence real wage rate, some people cannot survive and the population decreases.

45. LD1 Growth Begins LS0 5 New technologies and more capital increase the productivity of labor 4 Real wage rate (1776 shillings per day) 3 2 1 LD0 0 1 2 3 4 5 6 Labor (millions)

46. LS1 Subsistence real wage rate A Dismal Outcome LS0 5 When the real wage rate exceeds the subsistence level, the population increases 4 3 Real wage rate (1776 shillings per day) 2 LD1 1 0 1 2 3 4 5 6 Labor (millions)

47. Growth Theory Neoclassical Growth Theory Holds that real GDP per person grows because technological change induces saving and investment that makes capital per person grow. The Neoclassical Economics of Population Growth: • The population explosion of eighteenth century Europe that created the classical theory of population eventually ended. • Made classical theory less relevant.

48. Growth Theory Neoclassical Growth Theory Technological change • The rate of technological change influences the rate of economic growth, but economic growth does not influence the pace of technological change. • Technological change results from chance.

49. Growth Theory Neoclassical Growth Theory The Basic Idea • These technological advances bring new profit opportunities. • Businesses expand and new businesses are created to exploit the newly profitable technologies.

50. Growth Theory Neoclassical Growth Theory The Basic Idea (cont.) • Investment and savings increase. • The economy enjoys new levels of prosperity and growth.