Long-Run Growth and the Sources of Economic Growth

1. P R I N C I P L E S O F MACROECONOMICS T E N T H E D I T I O N CASE FAIR OSTER Prepared by: Fernando Quijano & Shelly Tefft

3. 17 CHAPTER OUTLINE Long-Run Growth The Growth Process: From Agriculture to Industry Sources of Economic Growth Increase in Labor Supply Increase in Physical Capital Increase in the Quality of the Labor Supply (Human Capital) Increase in the Quality of Capital (Embodied Technical Change) Disembodied Technical Change More on Technical Change U.S. Labor Productivity: 1952 I–2010 I Growth and the Environment and Issues of Sustainability

4. output growth The growth rate of the output of the entire economy. per-capita output growth The growth rate of output per person in the economy. labor productivity growth The growth rate of output per worker.

5. The Growth Process: From Agriculture to Industry  FIGURE 17.1Economic Growth Shifts Society’s Production Possibility Frontier Up and To the Right The production possibility frontier shows all the combinations of output that can be produced if all society’s scarce resources are fully and efficiently employed. Economic growth expands society’s production possibilities, shifting the ppf up and to the right.

6. The Growth Process: From Agriculture to Industry Beginning in England around 1750, technical change and capital accumulation increased productivity significantly in two important industries: agriculture and textiles. New inventions and new machinery meant that more could be produced with fewer resources. Growth meant new products, more output, and wider choice. A rural agrarian society was quickly transformed into an urban industrial society. Economic growth continues today in the developed world, and while the underlying process is still the same, the face is different. Growth comes from a bigger workforce and more productive workers. Higher productivity comes from tools (physical capital); a better-educated and more highly skilled workforce (human capital); and increasingly from innovation, technical change, and newly developed products and services.

7. The Growth Process: From Agriculture to Industry catch-up The theory stating that the growth rates of less developed countries will exceed the growth rates of developed countries, allowing the less developed countries to catch up. This idea that gaps in national incomes tend to close over time is called convergence theory. An economic historian coined the term the advantages of backwardness over 50 years ago to describe the phenomenon of less developed countries leaping ahead by borrowing technology from more developed countries.

8. Sources of Economic Growth aggregate production function A mathematical relationship stating that total GDP (output) depends on the total amount of labor used and the total amount of capital used. The numbers that are used in Tables 17.2 and 17.4 that follow are based on the simple production function Y = 3 × K1/3L2/3. Both capital and labor are needed for production and increases in either result in more output. Using this construct we can now explore exactly how an economy achieves higher output levels over time as it experiences changes in labor and capital.

9. Sources of Economic Growth Increase in Labor Supply

10. Sources of Economic Growth Increase in Labor Supply

11. Sources of Economic Growth Increase in Physical Capital

12. Sources of Economic Growth Increase in Physical Capital foreign direct investment (FDI) Investment in enterprises made in a country by residents outside that country.

13. Sources of Economic Growth Increase in the Quality of the Labor Supply (Human Capital)

14. E C O N O M I C S I N P R A C T I C E Education and Skills in the United Kingdom In discussions of using education and health care to boost labor productivity, the context is often the developing economies, where the overall level of health and education are low. Developed economies like the United Kingdom are also concerned about the skill level of their labor force as they contemplate their productivity and growth rates. U.K. Businesses Press for Focus on Skills The Wall Street Journal

15. Sources of Economic Growth Increase in the Quality of Capital (Embodied Technical Change) embodied technical change Technical change that results in an improvement in the quality of capital. Disembodied Technical Change disembodied technical change Technical change that results in a change in the production process. More on Technical Change invention An advance in knowledge. innovation The use of new knowledge to produce a new product or to produce an existing product more efficiently.

16. Sources of Economic Growth U.S. Labor Productivity: 1952 I–2010 I  FIGURE 17.2Output per Worker Hour (Productivity), 1952 I–2010 I

17. Growth and the Environment and Issues of Sustainability

18. Growth and the Environment and Issues of Sustainability  FIGURE 17.3The Relationship Between Per-Capita GDP and Urban Air Pollution One measure of air pollution is smoke in cities. The relationship between smoke concentration and per-capita GDP is an inverted U: As countries grow wealthier, smoke increases and then declines.

19. Growth and the Environment and Issues of Sustainability Much of Southeast Asia has fueled its growth through export-led manufacturing. For countries that have based their growth on resource extraction, there is another set of potential sustainability issues. Because extraction can be accomplished without a well-educated labor force, while other forms of development are more dependent on a skilled-labor base, public investment in infrastructure is especially important.

20. R E V I E W T E R M S A N D C O N C E P T S aggregate production function catch-up disembodied technical change embodied technical change foreign direct investment (FDI) innovation invention labor productivity growth output growth per-capita output growth