MACROECONOMICS
AND THE GLOBAL BUSINESS ENVIRONMENT
The Wealth of Nations
The Supply Side
3-2
Key Concepts
 Economic Growth



Total output (GDP) Growth
Importance of Trend Growth
Output per capita growth
 Elements of Growth



Labor
Capital
Total Factor Productivity
3-3
Economic Growth
 Economic Growth: an increase over time in the
quantity of goods and services produced by an
economy
 Rate of economic growth


Real GDP: adjusts for inflation
Real GDP per capita: adjusts for size of population
 Why do we care about economic growth?
 Affects human welfare
 A little increase in growth over a long period makes a
huge difference
 Trend growth more important than business cycle
3-4
The Importance of Economic Growth
U.S. Counterfactual History
$300,000
$200,000
Business Cycles still occur, but trend is key difference
$150,000
$100,000
$50,000
Actual Real GDP Per Capita
1% Higher Real GDP Per Capita
1997
1989
1981
1973
1965
1957
1949
1941
1933
1925
1917
1909
1901
1893
1885
1877
1869
1861
1853
1845
1837
1829
1821
1813
1805
1797
$0
1789
Per Capita Income
$250,000
3-5
The Importance of Economic Growth
 Is higher trend growth possible?
 Thomas Malthus (1798): No
 finite resources => limit to both economic and
population growth (i.e. more people, less economic
growth)
 “Malthusian Perspective”
 Economist Perspective- “Half a Billion
Americans?”(8/22/02 ): Yes


More people, more economic growth
How do we reconcile different views on growth?
 What view does the empirical evidence support?
3-6
The Importance of Economic Growth
3-7
The Evidence
Population Growth and Economic Growth
$40,000
7
$35,000
6
5
$25,000
4
$20,000
3
$15,000
2
$10,000
1
$5,000
$0
0
0
1000
1500
1600
1700
1820
World Real GDP
1870
1913
Population
1950
1973
1998
Billions of People
Billions of $
$30,000
3-8
The Evidence
World GDP Per Capita
$6,000
$5,000
$4,000
$3,000
$2,000
$1,000
$0
0
1000
1500
1600
1700
1820
1870
1913
1950
1973
1998
3-9
The Evidence
Real GDP Per Capita, 0-1998 AD
$30,000
$25,000
$20,000
$15,000
$10,000
$5,000
$0
0
500
Western Europe
Latin America
1000
1500
1550
1600
Eastern Europe
Japan
1650
1700
1750
Former USSR
Asia
1820
1870
1913
1950
1973
1998
Total Western Offshoots
Africa
3-10
The Evidence
Economic Growth: China vs. Western Europe
$20,000
$18,000
$16,000
Per Capita GDP
$14,000
$12,000
$10,000
$8,000
$6,000
$4,000
$2,000
$0
1000
1150
1300
1400
China
1500
1820
West Europe
1913
1950
2001
3-11
The Evidence
3-12
The Evidence
Real Per Capita GDP
3-13
The Evidence
 Evidence does suggest higher trend growth possible
for many countries
 Evidence also indicates that wide range of growth
rates for many countries


Why the difference?
Why do some countries take off when others do not?
 Again, important question since even a little difference
over a long time makes a big impact
3-14
Benefits of Economic Growth
 Growing population
 Sustain more people
 Life expectancy
 Longer lives, more accomplishments
 Improved standards of living
 Higher income levels, afford more leisure
 Poverty reduction
 A function of both inequality and economic growth
 Recent emphasis on increasing growth
 Inequality may not change
3-15
Inequality and Growth
More Inequality 
0.80
0.70
0.60
0.50
0.40
0.30
0.20
-10
-5
0
5
10
Growth Rate
15
20
3-16
2004 Real Per Capita GDP (PPP)
$45,000
$40,000
$35,000
$30,000
$25,000
$20,000
$15,000
$10,000
$5,000
ep
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s
ta
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To
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Ja
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Ko
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$0
3-17
Explaining Differences in GDP per capita
GDP per capita =
GDP
Population
GDP
Hours
Number Employed Labor Force




Hours Number Employed
Labor Force
Population
Labor Productivity
Average Hours Worked
Employment Rate
Labor Force
Participation Rate
3-18
Explaining Differences in GDP per
capita (2001)
GDP per capita
Country
U.S.
Japan
Korea
Denmark
France
Germany
Italy
Netherlands
Norway
Sweden
U.K.

GDP
Hours
Number Employed Labor Force



Hours Number Employed
Labor Force
Population
GDP per
Capita ($PPP)
33869
25480
15226
28360
24230
25427
25055
27337
30691
25580
24819
Hourly
Productivity
($PPP)
38.28
27.96
13.66
37.28
39.27
36.67
38.29
40.08
43.86
32.65
30.92
Average
Hours
Worked
1821
1821
2447
1482
1532
1467
1606
1346
1364
1603
1711
Employment
Rate
0.952
0.949
0.961
0.957
0.915
0.92
0.904
0.976
0.964
0.95
0.949
Participation
Rate
0.51
0.53
0.47
0.54
0.44
0.51
0.45
0.52
0.53
0.51
0.49
•U.S. success more than labor productivity: avg. hours worked,
employment rate, & participation rate important
•Two policy implications: focus on factors that (1) boost labor productivity
and (2) increase labor market flexibility
•However, only increases in labor productivity can produced sustained
increased in GDP per capita
3-19
Role of Inputs
 More inputs means more output
 Diminishing returns



1 worker = $10 in output
2 workers = $18 in output
3 workers = $24 in output
Marginal return is
$8 in output
Marginal return is
$6 in output
3-20
Analysis of Growth
Capital
(buildings,
infrastructure
and
machines)
Output (GDP)
Labor
(Hours worked, number
of workers)
Total Factor
Productivity
(technological
knowledge
and
efficiency)
3-21
Production Function
Output = TFP  Capital Stocka  Labor Hours(1-a)
Real GDP
A parameter
(a number, 0 < a < 1)
Total Factor Productivity
•Total factor productivity (TFP) measures how effectively the inputs are
turned into output
•True impact of capital and labor depend on their marginal product:
how much output will the next additional input add to output
•diminishing marginal returns: holding other inputs and TFP fixed, the
marginal product of an input increases at a decreasing rate
3-22
Cobb-Douglas example
1000
Real GDP
900
800
700
TFP = 1
Capital = 500
a=0.6
600
500
400
300
200
100
0
0
500
1000
1500
2000
2500
Hours worked
3-23
Output  (500)0.6  (Labor Hours)0.4
Real GDP
1000
900
800
700
600
500
400
300
200
100
0
0
500
1000
1500
2000
2500
Hours Worked
3-24
Output  (Capital Stock)0.6  (1000)0.4
1800
Output
1600
1400
1200
1000
800
600
400
200
0
0
500
1000
1500
2000
2500
Capital Stock
3-25
Implications for labor productivity
Output = TFP  Capital Stocka  Labor Hours(1-a)
 Capital 
GDP
 TFP  

Labor Hours
 Labor Hours 
Labor Productivity
Changes in Labor Productivity
(1) Total Factor Productivity
(2) Capital per Labor Hour
a
3-26
Implications for Labor Productivity
 Capital 
GDP
 TFP  

Labor Hours
 Labor Hours 
a
implies…
 Capital 
% Labor Productivity = % TFP  a  % 

 Labor Hour 
3-27
Labor Productivity
Labor Productivity = TFP  (Capital Stock/Labor Hours)a
12
8
500
1000
Capital Stock per labor hour
3-28
Increase in TFP
Output/Labor Hour = TFP  (Capital/Labor Hour)a
Labor Productivity
y2
y1
k1
Capital Stock per Labor Hour
3-29
3-30
3-31
U.S.Labor
LaborProductivity
ProductivityDecomposition
Decomposition
3
2.5
2
1.5
1
0.69
0.51
0.5
0.57
0.43
0.19
0
1800-1855
1855-1890
1890-1927
Labor Productivity
TFP contribution
1929-1966
Capital Stock/Labor
1966-1989
3-32
Growth in Output
 Increase in labor supply
 May have no impact on GDP per capita
 Not sustainable
 Diminishing returns
 Increase in capital stock
 Must increase at faster rate than labor &
depreciation
 Diminishing returns
 Increase in TFP
 No diminishing returns in this framework
 Intensive vs. extensive economic growth
 More of the same growth vs. more growth with less
resources
3-33
Growth Accounting
Production Function
Output = TFP  Capital Stocka  Labor Hours(1-a)
Take the logarithms, and then changes in the logarithms
%∆ Output = %∆TFP + a x %∆Capital Stock + (1-a) x %∆ Labor Hours
Steps
•Find percent change in capital stock and labor inputs multiplied by
their weights
•Find percent change in output
•Difference between two or the residual is the percent change in total
factor productivity
3-34
Growth accounting for Japan, Germany, the UK, and the United
States, 1913–1950.
3-35
Growth accounting for Japan, Germany, the UK, and the United
States, 1950–1973.
3-36
Growth accounting for Japan, Germany, the UK, and the United
States, 1973–1992.
3-37
Europe and Asia
Total Output:
Of Which
Capital
Labor
TFP
Golden Age 1950-73
France
UK
W. Germany
Asian Miracle 1960-94
5.0%
3.0%
6.0%
1.6%
1.6%
2.2%
0.3%
0.2%
0.5%
3.1%
1.2%
3.3%
China
Hong Kong
Indonesia
Korea
Thailand
Singapore
6.8%
7.3%
5.6%
8.3%
7.5%
8.5%
2.3%
2.8%
2.9%
4.3%
3.7%
4.4%
1.9%
2.1%
1.9%
2.5%
2.0%
2.2%
2.6%
2.4%
0.8%
1.5%
1.8%
1.5%
Europe relied on capital and TFP
– Asian countries have relied on capital
3-38
Growth Accounting
 Japan


Capital growth important through out
Labor, TFP important ’50 – ’73
 US



TFP important until ’73
Labor important after ’73 thru mid 1990s
Productivity strengthens in mid1990s
 UK and Germany rely less on labor
3-39
Growth Accounting
Asian Tigers, 1966 - 1990
3-40
China vs. India 1993-2004
3-41
Growth accounting in emerging markets, 1960–1994.
3-42
Summary
 Importance of Growth
 Sources of Growth
 GDP per capita
 Hourly productivity
 Number of hours worked
 Productivity
 Capital Accumulation
 TFP
 Growth Accounting