ANSWERS TO CHECKPOINT EXERCISES
 CHECKPOINT 10.1 The Basics of Economic Growth
1a. Canada’s economic growth rate = [($1,028 billion – $1,012 billion)  $1,012]
billion  100 = 1.6 percent.
1b. The growth rate of Canada’s population is [(31.1 million  30.8 million) 
30.8 million]  100, which is 1.0 percent. Canada’s growth rate of real GDP
per person = 1.6 percent – 1.0 percent = 0.6 percent.
1c. Real GDP per person doubles in approximately 70  0.6 = 116.7 years.
1d. If the growth of real GDP rises to 6 percent and the population growth rate
remains 1.0 percent, then the growth in real GDP per person is 6.0 percent –
1.0 percent = 5.0 percent. Real GDP per person doubles in approximately 70
 5.0 = 14.0 years.
 CHECKPOINT 10.2 The Sources of Economic Growth
1a. Growth rate of real GDP in 2001 = [($9,215 billion – $9,191 billion)  $9,191
billion] 100 = 0.3 percent.
1b. Labor productivity in 2000 = $9,191 billion  240.6 billion hours = $38.20 an
hour. Labor productivity in 2001 = $9,215 billion  238.8 billion hours =
$38.59 an hour.
1c. The growth rate of labor productivity equals the change in labor
productivity divided by the initial level, times 100, which is [($38.59 –
$38.20)  $38.20]  100 = 1.02 percent
1d. The one third rule identifies the contribution of growth in capital per hour
of labor to growth in labor productivity. Using the data in the table, capital
per hour of labor grew by [($102.13 – $98.91)  $98.91]  100 = 3.26 percent.
The one third rule tells us that 1/3 of 3.26 percent, which is 1.09 percent, of
the growth in labor productivity came from capital growth. The growth in
capital per hour of labor is 0.07 percent greater than the growth in labor
productivity. So changes in human capital and technology decreased labor
productivity by 0.07 percent.
 CHECKPOINT 10.3 Theories of Economic Growth
1.
The modern theory of economic growth points out that a key economic
influence on population growth is the opportunity cost of a women’s time.
As wage rates for women rise, so does the opportunity cost of having
children. This leads women to have fewer children, which leads to a decline
in the birth rate. The second force is the death rate. Technological advances
increase labor productivity and also bring advances in health care, which
extends lives. Because these forces are offsetting, the modern theory of
population growth concludes that the rate of population growth is
independent of the rate of economic growth. This conclusion contradicts
the classical growth theory, which assumes that the population growth rate
increases when real GDP per person rises above the subsistence level.
2.
The main limitation of neoclassical growth theory is that it predicts that real
GDP per person grows at a rate that is determined by the pace of
technological change. But, the theory does not explain what determines
technological change. Neoclassical growth theory contends that
technological advances are merely up to chance.
3.
First, human capital grows because of choices. Second, discoveries result
from choices. Lastly, discoveries bring profit and competition destroys
profit. With respect to the first factor, the influence that guides human
capital growth depends on how long people remain in school, what they
study, and how hard they study. Discoveries result from choices, which
depend on how many people are looking for new technology and how
intensively they are looking, not mere luck. And, competition serves to
squeeze profits. People are constantly seeking lower-cost methods of
production or new and better products, which leads to economic growth.
4.
New growth theory suggests that diminishing returns are not growth
limiting because as capital accumulates, labor productivity grows
indefinitely as long as people devote resources to expanding human capital
and introducing new technologies. In addition, new growth theory points
out that even though there might be diminishing returns to a firm, there are
not necessarily diminishing returns to the economy as a whole because
activities can be replicated. In other words, it is possible for the economy as
a whole to add another, say, computer chip factory identical to a first
factory. Because the second factory is identical to the first, the output
should be identical to the first and so the economy as whole does not
experience diminishing returns.
5.
According to classical theory, an effort by China to slow population growth
by limiting the number of children in each family initially would have the
effect of increasing the amount of capital per hour of labor. So, labor
productivity and real GDP per person increase. As GDP per person rises,
real GDP per person rises above the subsistence level and population
should increase yet again. The overall effect is unclear: If China can
successfully limit population growth in face of the tendency for it to
increase when real GDP per person rises, then real GDP per person can
remain above the subsistence level. However, if China's best efforts are
insufficient, then the rise in GDP per person serves to increase population
growth and real GDP per person returns to the subsistence level.
Neoclassical theory argues that the reduction in population from limiting
the number of children unleashes several forces. First, because real GDP
grows at a rate that equals the growth in population times the growth in
productivity, the reduction in the number of children slows population
growth and so slows growth in real GDP. However, the effect on growth in
real GDP per person is less dramatic. In particular, because growth in real
GDP per person depends on growth in technology and growth in
technology is random, China’s population program should have no direct
effect on growth in real GDP per person.
According to new growth theory, the pace at which new discoveries are
made and at which technology advances depends on how many people are
looking for a new technology and how intensively they are looking. This
assumption leads to the conclusion that efforts to limit population through
regulating the number of children that people are allowed to have will lead
to a reduction in the discovery of new technologies and a decrease in the
rate of labor productivity growth. So, China’s growth policy slows the
growth in real GDP per person.
 CHECKPOINT 10.4 Achieving Faster Growth
1.
The key reason why economic growth is either absent or slow is that some
societies lack the incentive system that encourages growth-producing
activities. And economic freedom is the fundamental precondition for
creating the incentives that lead to economic growth.
2.
Russia probably experiences slow economic growth for several reasons: an
inefficient legal system, corruption in the courts and government, and a
large presence of organized crime, which interferes with the rule of law and
tramples on property rights. Economic freedom, particularly protection of
property rights, is woefully lacking in Russia.
3.
Economic freedom is not the same as democracy. The rule of law is the key
requirement to economic freedom, not democracy. Several non-democratic
countries enjoy economic freedom and achieve rapid economic growth.
Malaysia and Singapore are examples of non-democratic but rapidly
growing nations.
4.
Markets enable people to trade and to save and invest. Markets are where
buyers and sellers get information and do business with each other.
5.
Free trade stimulates growth by extracting all the available gains from
specialization and exchange. Countries that have substantial trade barriers
often have slower economic growth because the restrictions they impose on
their countries promote inefficient industries and punish potentially
efficient industries that could find markets beyond their borders.
ANSWERS TO CHAPTER CHECKPOINT EXERCISES
1.
The reason that sustained growth of real GDP per person can transform a
poor country into a wealthy one is that economic growth is like compound
interest. In other words, as the economy grows, in future years the growth
rate is applied to a larger and larger real GDP per person and so the gain is
larger and larger.
2.
Using the Rule of 70, Ireland’s real GDP per person doubles in 70  10 = 7
years. So real GDP per person would be twice what it was in 2000 in the
year 2007.
3.
Over the past 100 years, U.S. real GDP per person has increased at an
annual average rate of 2 percent, but the rate of growth has not been
steady. U.S. real GDP per person decreased during the early 1930s and
then grew until the end of World War II. After the end of World War II,
real GDP per person decreased for a couple of years, but then resumed its
growth. The most rapid growth occurred during the 1960s. Growth was
slower in the 1970s, 1980s and early 1990s, though in the later 1990s,
growth in real GDP per person has picked up the pace.
4.
Saving and investment increase the amount of capital. Formal education
and training, as well as job experience, increase human capital. Technology
advances with the discovery of new and better ways to produce existing
goods and services or with the discovery of new goods and services. Firms
routinely conduct research to develop technologies that are more
productive and partnerships between business and the universities are
commonplace in fields such as biotechnology and electronics.
5.
Labor productivity = (Real GDP)  (Aggregate hours). So, Real GDP =
(Labor productivity)  (Aggregate hours). Real GDP grows when labor
productivity increases or when aggregate hours increase.
6.
A productivity curve shows the relationship between real GDP per hour of
labor and the quantity of capital per hour
of labor with a given state of technology.
An increase in human capital or a
technological
advance
shifts
the
productivity curve upward. A change in
capital per hour of labor leads to a
movement along the productivity curve. A
productivity curve is illustrated in Figure
10.2.
7.
Saving and investment in new capital increase capital per hour of labor, which
leads to an increase in labor productivity.
An increase in capital per hour of labor
results in a movement along the curve, as
illustrated in Figure 10.3 by the movement
from point a to point b along productivity
curve PC0. An increase in human capital or
an advance in technology also increases
labor productivity. When human capital
advances or technology advances, the
productivity curve shifts upward, as
illustrated in Figure 10.3 by the shift in the
productivity curve from PC0 to PC1.
8.
The one third rule is the observation that on the average with no change in
human capital or technology, a one percent increase in capital per hour of
labor brings a one third percent increase in labor productivity. The one
third rule was discovered by Robert Solow, an MIT economist. The one
third rule is used to identify the contribution of capital growth to labor
productivity growth.
9.
Capital per hour of labor growth of 6 percent increases labor productivity
by (1/3)  (6 percent) = 2 percent. Factors other than capital per hour of
labor that increase labor productivity are growth in human capital and
technological change. In the question, growth in capital per hour of labor
contributed 2 percent of the growth in labor productivity. Because labor
productivity grew 5 percent, 5 percent minus 2 percent, or 3 percent, is the
growth that is the result of increases in human capital and technological
change.
10. No. The economy conforms to a one-half rule. In this economy, an x
percent increase in capital per hour of labor leads to a 0.5x percent increase
in real GDP per hour of labor. You can confirm this fact by calculating the
percentage change in capital per hour of labor and real GDP per hour of
labor at each of the levels provided in the table and then dividing the
percentage change in real GDP per hour of labor by the percentage change
in capital per hour of labor. For example, when capital per hour of labor
increases by 100 percent from $10 to $20, real GDP per hour of labor
increases by 50 percent from $3.80 to $5.70. Growth accounting for this
economy would be done precisely as it is for the U.S. economy, but using a
one half rule to determine the effect of changes in capital per hour of labor
rather than a one third rule.
11a. Yes, Longland experiences diminishing returns. When diminishing returns
are present, each additional unit of capital per hour of labor produces a
successively smaller additional amount of real GDP per hour of labor. The
data given for Longland’s productivity curve demonstrates that Longland
experiences diminishing returns. The increase in real GDP per hour of
labor that occurred in the question results from an increase in capital and
an advance in technology. We know this because labor productivity of
$10.29 an hour in 2001 would have required capital per hour of labor of
$60, and in 2003, this labor productivity occurs with capital per hour of
labor of $50.
11b. The contribution of the change in capital to the growth of labor
productivity is calculated using the one half rule established in Exercise 10.
Capital per hour of labor increased by [($50  $40)  $40]  100, which is 25
percent. So, capital per hour of labor contributed a 1/2  25 percent, which
is 12.5 percent increase in real GDP per hour of labor.
11c. Between 2001 and 2003, real GDP per hour of labor increased by [($10.29 
$8.31)  $8.31]  100, which is 23.8 percent. As part (b) showed, the increase
in capital per hour of labor contributed a 12.5 percent increase in labor
productivity, so technological change contributed 23.8 percent  12.5
percent, which is an increase of 11.3 percent.
12a. Capital per hour of labor is $40 and real GDP per hour of labor is $15.
12b. Real GDP per hour of labor rises by $7 (to $22 per hour of labor) after the
technological advance.
12c. The population growth rate increases because real GDP per hour of labor is
above the subsistence level.
12d. Real GDP per hour of labor eventually falls to $15. With the $7 increase
that resulted from the technological advance, capital per hour of labor
eventually is $20 because at this capital per hour of labor, the real GDP per
hour of labor is $15.
13. The classical growth theory predicts that all nations will eventually reach
and then remain at a subsistence level of real GDP per person. So the
classical theory predicts that the nations with the highest levels of real GDP
per person should have the highest population growth rates and be the
first to have slowing, and then negative growth in real GDP per person.
The neoclassical growth theory predicts that real GDP per person
continues to grow in the global economy as long as technology continues
to advance. It also predicts that real GDP per person in the different
nations will converge to the same level because nations have access to the
same technology and because capital markets equalize the amount of
capital per hour of labor in each nation.
New growth theory predicts that national growth rates depend on
national incentives to save, invest, accumulate human capital, and
innovate. Because these incentives depend on factors that are special to
each country, national growth rates will not necessarily converge so that
real GDP gaps between countries might persist and others might close
New growth theory fits the facts more closely than do the other two
theories. For instance, Hong Kong and India are good examples of
economies that were in dismal shape fifty years ago, with low productivity
and widespread poverty. Hong Kong turned itself around but we cannot
say the same for India. The likely explanation for this difference is the better
incentives to increase capital and technological advances that exist in Hong
Kong and are missing in India.
14. To encourage economic growth, governments can create incentive
mechanisms (such as secure property rights and legal system), encourage
saving, encourage research and development, encourage international
trade, and improve the quality of education.
 Critical Thinking
15. Governments in Africa have to focus on increasing economic freedom
within their countries. They need to end any wars in which they are
involved to return to the rule of law and provide secure property rights.
They also need to provide greater access to education to improve their
citizens’ human capital as well as establish truly free markets.
16. Living standards in Asian economies have increased because many of the
governments in this region have provided greater economic freedom for
their people, established property rights, and have encouraged
international trade. Asian economies also have higher saving rates than in
the United States.
17. Economic freedom is present when people are able to make personal
choices, their private property is protected, and they are free to buy and sell
in markets. Private property is necessary to provide people with the
incentive to work and save. Markets are necessary because they allow
prices to send signals to buyers and sellers that create incentives to increase
or decrease the quantities demanded and supplied. Nations that do not
enjoy political freedom and have low growth rates abound. The nations
your students list might differ from those listed here, so you must be the
ultimate judge of the suitability of the students’ choices. Some nations that
fall into this category include Chad, Cuba, Iraq, and North Korea. Nation
that enjoy economic freedom and have high economic growth rates include
South Korea and the United States. Japan is a recent example of a country
with economic freedom but little economic growth.
19. Statement (1) reflects the new growth theory view of the world: Economic
growth depends on people’s choices. Statement (2) reflects the classical
growth theory view of the world: A population explosion runs up against a
resource limit and growth stops. Of the two assertions, probably more
people believe statement (2) but statement (1) is closer to being accurate.
There are not any good examples of nations that grew more rapidly after
slowing population growth but there are many examples of nations in
which population growth slowed after economic growth occurred. Nor are
there many good examples of a nation’s growth screeching to a halt because
it ran out of a resource. Statement (1) also points out that if a nation is
running out of a resource, technological advances can occur that create
substitutes for the depleting resource.
20. This development should increase economic growth in China because it
increases China’s human capital. The Chinese government would be wise if
it adopted policies that encourage more Chinese students to return to China
when they are done with their studies because human capital is one of the
key engines leading to economic growth.