Chapter 8: Economic Growth
I. The Significance of Economic Growth
A. Defining Economic Growth
1. Economic growth is a reflection of changes in potential output or
a shift to the right in the long-run aggregate supply curve.
2. Economic growth has three characteristics.
a. Economic growth is a process, not a single event.
b. Economic growth reflects the economy’s ability to produce
goods and services.
c. Economic growth suggests that the economy’s ability to
produce goods and services is rising.
3. Real GDP data can seem to indicate growth when they really
only show cyclical fluctuations about potential output.
B. The Rule of 72 and Differences in Growth Rates
1. Over time, small differences in growth rates create large
differences in incomes.
2. Exponential growth occurs when a quantity grows at a given
percentage rate.
3. The rule of 72 states that a variable’s approximate doubling time
equals 72 divided by the growth rate stated as a whole number.
C. Growth in Output per Capita
1. Output per capita equals GDP per person.
2. Real GDP/ Population = real per capita output.
3. Real per capita output is used as a measure of material standard
of living. If population is growing, real GDP must grow as rapidly as
population in order to maintain a constant per capita output.
4. Percentage rate of growth of output per capita = percentage rate
of growth of output–percentage rate of growth of population.
5. For economic growth to translate into a higher standard of living
on average, economic growth must exceed population growth.
II. Growth and the Long-Run Aggregate Supply Curve
A. The Aggregate Production Function
1. An aggregate production function relates the total output of an
economy to the total amount of labor employed in the economy, all
other determinants of production unchanged.
2. An economy operating on its aggregate production function is
producing its potential level of output.
3. Diminishing marginal returns occur when additional units of a
variable factor add less and less to total output, given constant
quantities of other factors.
4. The shape of the aggregate production function shows
diminishing marginal returns to labor.
B. The Aggregate Production Function, the Market for Labor, and
Long-Run Aggregate Supply
1. The labor market is in equilibrium at the natural level of
employment.
2. Labor supply and demand intersect at the real wage that occurs
at the natural level of employment.
3. Potential output can be determined as the level of output that
corresponds to the natural level of employment, given the natural
level of employment and the aggregate production function.
4. The long-run aggregate supply curve is a vertical line at the
potential output found in 3 above.
C. Changes in Long-Run Aggregate Supply
1. A change in the production function will change the long-run
aggregate supply.
a. A change in technology could shift the production function.
b. A change in the capital stock could shift the production
function.
c. A change in the availability of natural resources could shift
the production function.
2. When the production function shifts upward, labor is more
productive than before.
a.Labor productivity is output per worker.
b. An increase in labor productivity generates an increase in
the real wage through a shift in the demand for labor.
c. When the production function shifts upward, the natural
level of employment generates more potential output than
before through both increased employment (a new higher
level of natural employment) and increased labor
productivity.
d. The long-run aggregate supply curve shifts to the right to
account for the higher potential output.
e. The common belief that technological change (or
increases in the capital stock) reduces demand for labor,
reduces employment, and reduces real wages is shown by
this analysis to be wrong.
f. Some specific jobs are lost to technological change, but
jobs as a whole increase and they generally offer higher
wages.
g. An increase in the supply of labor can shift the long-run
aggregate supply.
h. Increases in the supply of labor can occur in three ways.
i. Immigration
i. Increases in the supply of labor generate a higher
level of natural employment at a lower real wage in
the labor market.
ii. Increases in the population
iii. Increases in the participation rate
j. Because technology and the supply of other resources
have not changed, the aggregate production function does
not change.
k. The new natural level of employment causes an increase
in potential output.
l. The long-run aggregate supply shifts to the right but at the
cost of lower real wages.
m. Labor supply and the aggregate production function can
both increase and the gain in productivity can offset the
supply effect on wages. The result is an increase in labor, an
increase in the real wage, and an increase in potential
output.
n. Economic growth occurs only if an event shifts the
economy’s production function or if there is an increase in
the demand or supply of labor.
III. Determinants of Economic Growth
A. The Sources of Economic Growth
1. Economic growth can be modeled in two ways.
a. An outward shift in an economy’s production possibilities
curve.
b. A shift to the right of its long-run aggregate supply curve.
2. Anything that increases the quantity or quality of factors of
production or that improves the technology available to the
economy contributes to economic growth.
3. Higher savings rates contribute to higher rates of capital
formation and higher rates of economic growth.
4. Chapter 2 indicated that the sources for U.S. economic growth in
the twentieth century were increases in labor and capital during the
first half and increases in human capital and technology in the
second half.
B. Explaining the Great Slowdown: Cause for Alarm?
1. The great slowdown in economic growth was global in nature.
2. The great slowdown in economic growth cannot be explained in
terms of any one country.
3. Several explanations have been offered.
a. Measurement errors
b. Higher oil prices
c. Slowing growth in human capital
d. Government regulation
e. Higher inflation
f. Running out of ideas