VI. Economic Growth and Productivity (5-10%)
Real GDP per Capita. Real GDP divided by the population size.
• GDP measures total value of an economy’s production of final goods and services as well as income earned in that economy in a given year.
• Real GDP to separate changes in quantity of goods and services from effects of rising price level. Size of economy after adjusting for inflation.
• Real GDP per capita to isolate effect of changes in population. Size of each person’s share of the economy, if it were shared equally.
Example. Other things equal, an increase in population lowers standard of living for average person—there are now more people to share a given amount of real GDP. An increase in real GDP that only matches an increase in population leaves the average standard of living unchanged.
Growth Rates. Growth rates are like compounded interest.
If the annual interest rate is
10% at the bank, and you are saving $100, after year 1 you will have $110, an increase of $10.
After year two, you will have $121, an additional increase of $11.
If the economy grows by 2% one year, and another 2% the following year, and another 2% the year after that, these annual growth rates are compounded into larger and larger increases in per capital real GDP.
Rule of 70. Rule of 70 approximates how many years it will take for economy to double at a given rate of economic growth.
# of years for a number to double = (70/annual growth rate of that number)
Example. If annual per capita real GDP increases at 5% every year, it will take approximately 14 years for it to double.
Sources of Long-Run Economic Growth: Productivity. Sustained growth in real GDP per capita occurs only when amount of output produced by the average worker increases steadily.
Labor productivity = (real GDP/# of people working)
If workers are creating more output, on average, the size of the economy will be rise and the average person’s share will also be rise.
Factors for High Productivity
 Physical Capital. If you give a worker more physical capital (tools) with which to do the work, he/she will almost always be more productive.
 Human Capital. If a worker has more education and training, human capital, he/she tends to be more productive. o As jobs and global economy become more complex, nations with a more highly educated workforce will be able to produce more output per worker than nations
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with a lower level of education.
 Technology. Innovations are major factors in allowing an average worker to increase his/her output in a given year.
So, if you give a worker more tools, better tools, and the education and training to know what to do with them, that worker will be more productive.
Productivity and Growth
Accounting for Growth: Aggregate Production Function. Economists make use of tons of macroeconomic data to statistically estimate the nation’s aggregate production function, which shows how productivity depends on quantities of physical capital per worker and human capital per worker as well as the state of technology. Diminishing returns to physical capital: all else equal, as physical capital is increased, aggregate output increases by a smaller amount. Upward sloping curve, which flattens near top because of diminishing returns.
GDP per worker = T x (Physical capital per worker) 0.4
x (Human capital per worker) 0.6
T: Estimated level of technology.
AP Exam: Will not cover growth accounting, but should be familiar with concept of aggregate production function.
Why Growth Rates Differ. Small differences in growth rates matter.
Example. Jane and Amanda both have $10,000 and they want to save that money for retirement in 30 years. Jane can invest her money at an annual rate of 3%.
Amanda can invest her money at a slightly smaller annual rate of 2.5%.
Jane's money in 30 years grows to: $10,000(1.03) 30 = $24,272.62
Amanda's money in 30 years grows to: $10,000(1.025) 30 = $20,975.69
The ratio of Amanda's nest egg divided by Jane's is equal to .86. In other words, after 30 years Amanda's money is 14% below the level of Jane's.
Capital, Technology, and Growth Differences
 Adding to Physical Capital. Investment spending comes from national savings and foreign capital inflow. Nations that have a high saving rate will have a high capital investment rate and faster economic growth.
 Adding to Human Capital. Nations with higher rates of educational attainment have enjoyed faster rates of economic growth.
 Technological Progress. New technologies are the result of scientific research, or research and development (R & D).
Nations that invest in R & D should experience more economic growth than nations that do not.
Role of Government in Promoting Economic Growth
 Governments and Physical Capital. Governments provide infrastructure by building roads, airports, seaports, electrical grids and many others. These systems help
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consumers and firms engage in economic activity that promotes economic growth.
Private firms also invest in physical capital. If government can provide infrastructure and maintain a financial system that provides for saving and borrowing that is required for private investment, a nation’s physical capital will grow.
 Governments and Human Capital. Governments pay for vast share of primary and secondary education. When nations make education a higher priority, they subsidize it.
More people acquire education and nation prospers with long-run economic growth.
 Governments and Technology. While much R & D is done by private companies, government subsidizes this research with grants. Government also provides direct support and grant money to professors at public and private universities and that research helps drive technological progress.
 Political Stability, Property Rights, and Excessive Government Intervention.
Assume a business wants to build a factory that produces gadgets in a
Badinvestmentstan. Businesses will be very hesitant to invest in Badinvestmentstan if government might be overthrown, or if government could just claim factory as government property (nationalization). Or maybe Badinvestmentstan's courts and government bureaucracies are corrupt so that day-to-day business transactions require bribes. Firms are not going to want to invest in nations such as this. On the other hand, the government could excessively intervene in markets with high taxes, tariffs, or other anti-competitive policies. This can slow down economic growth.
Problems with Sustainable World Growth
 Limited Natural Resources: supplies, new technologies to find new resources, longrun growth vs. scarcity.
 Economic Growth and the Environment: climate change (negative externality); economists believe in gradual implementation of policies such as carbon taxes and capand-trade legislation that will reduce emissions without major damage to the economy.
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Long-Run Economic Growth and PPC.
Long-run economic growth is sustained rise in quantity of g/s economy produces, as opposed to the short-run ups and downs of the business cycle.
Example. X and Y have same PPC in
2010. X chooses a point like A, where most resources are used to produce consumption goods. Y chooses a point like
B, where most resources are used to produce investment goods. Where will these PPC’s lie in 20 years?
Both X and Y will experience growth in
PPC, but Y experiences more growth over time because investments in physical capital goods produce other goods. In fact, if X focuses solely on consumption goods, their current stock of physical capital will begin to depreciate. Machinery used to produce other goods eventually wears out and becomes useless. If this were to happen the
PPC could even shift inward.
Long-Run Economic Growth and
AD/AS Model. In AD/AS model, LRAS shows relationship between APL and quantity of aggregate output supplied when all prices including nominal wages are flexible. LRAS is vertical at the level of Y
P
.
While actual real GDP is almost always above or below Y
P
, reflecting current phase of business cycle, Y
P
is level of output around which actual aggregate output fluctuates.
Distinguishing Between Long-run Growth and Short-run Fluctuations. LR economic growth is sustained rise in quantity of g/s economy produces, as opposed to SR ups and downs of the business cycle. For PPC, a short-run fluctuation is described as a movement along, or within PPC. LR growth is a fundamental shift outward of PPC.
In AD/AS model, short-run fluctuation of business cycle would be seen as a shift of AD or
SRAS. Recessionary gap is result of decrease in AD or decrease in SRAS. AD/AS model predicts that in LR economy will adjust to full employment, which is identified by vertical
LRAS curve.
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AP Exam 1990
1.
Increases in real income per capita are made possible by a.
improved productivity b.
a high labor/capital ratio c.
large trade surpluses d.
stable interest rates e.
high protective tariffs
AP Exam 1995
2.
An increase in which of the following is most likely to cause an improvement in the standard of living over time? a.
Size of the population b.
Size of the labor force c.
Number of banks d.
Level of taxation e.
Productivity of labor
3.
An increase in which of the following is most likely to increase the long-run growth rate of an economy’s real per capita income? a.
Population growth b.
The proportion of gross domestic product consumed c.
The educational attainment of the population d.
The supply of money in circulation e.
Personal income taxes
4.
Changes in which of the following factors would affect the growth of an economy?
I.
Quantity and quality of human and natural resources
II.
Amount of capital goods available
III.
Technology a.
I only b.
I and II only c.
I and III only d.
II and III only e.
I, II, and III
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1.
A
2.
E
3.
C
4.
E
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