7

Learning Objective 10.1
http://www.uwyo.edu/askiba/macro.asp
Economic Growth Over Time and Around the World
Economic Growth from 1,000,000 B.C. to the Present
FIGURE 10-1
Average Annual
Growth Rates for the World Economy

Learning Objective 10.1
Economic Growth Over Time and Around the World
“The Rich Get Richer and . . . ”
FIGURE 10-2
GDP per Capita, 2006

Learning Objective 9.1
Long-Run Economic Growth
Long-run economic growth The process by which rising productivity increases the average standard of living.
FIGURE 9.1
The Growth in Real GDP per Capita, 1900 –2006

Learning Objective 9.1
Long-Run Economic Growth
Potential GDP The level of
GDP attained when all firms are producing at capacity.
FIGURE 9.2
Actual and Potential Real GDP
Business cycle Alternating periods of economic expansion and economic recession.

Learning Objective 9.1
Making the
Connection
The Connection between
Economic Prosperity and Health

Learning Objective 10.1
Economic Growth Over Time and Around the World
Small Differences in Growth Rates Are Important
In the long run, small differences in economic growth rates result in big differences in living standards.
Why Do Growth Rates Matter?
Growth rates matter because an economy that grows too slowly fails to raise living standards.
Don’t Let This Happen to YOU!
Don’t Confuse the Average Annual Percentage
Change with the Total Percentage Change

Learning Objective 10.1
Making the
Connection
The Benefits of an Earlier Start:
Standards of Living in China and Japan
Sustained high rates of economic growth have helped Japan attain high living standards.
CHINA JAPAN
Life expectancy at birth 71.9 years 82.2 years
Infant mortality (per
1,000 live births) 23 3
Percentage of the population surviving on less than $2 per day 47% 0%
Percentage of the population with access to treated water
Percentage of the population with access to improved sanitation
Internet users per 1,000 people
77%
44%
73
100%
100%
587

Long-Run Economic Growth
Calculating Growth Rates and the Rule of 70
Learning Objective 9.1
Number of years to double

70
Growth rate

Learning Objective 10.2
What Determines How Fast Economies Grow?
Labor productivity The quantity of goods and services that can be produced by one worker or by one hour of work.
Technological change A change in the quantity of output a firm can produce using a given quantity of inputs.

Learning Objective 10.2
What Determines How Fast Economies Grow?
There are three main sources of technological change:
• Better machinery and equipment.
• Increases in human capital.
Human capital The accumulated knowledge and skills that workers acquire from education and training or from their life experiences.
• Better means of organizing and managing production.

Learning Objective 10.2
What Determines How Fast Economies Grow?
Which Is More Important for Economic Growth:
More Capital or Technological Change?
The Per-Worker Production Function
FIGURE 10-3
The Per-Worker Production Function

Learning Objective 10.2
What Determines How Fast Economies Grow?
Technological Change:
The Key to Sustaining Economic Growth
FIGURE 10-4
Technological Change
Increases Output per
Hour Worked

Learning Objective 10.2
What Determines How Fast Economies Grow?
If technological change is the key to growth then what encourages the technological change
New growth theory : “incentives and market system”

Making the
Connection
Why Did the Soviet Union’s
Economy Fail?
Learning Objective 10.2
The fall of the Berlin Wall in 1989 symbolized the failure of Communism.

Learning Objective 10.2
What Determines How Fast Economies Grow?
New Growth Theory
Government policy can help increase the accumulation of knowledge capital in three ways:
• Protecting intellectual property with patents and copyrights.
Patent The exclusive right to a product for a period of 20 years from the date the product is invented.
• Subsidizing research and development.
• Subsidizing education.

Learning Objective 10.4
Why Isn’t the Whole World Rich?
Catch-up: Sometimes, but Not Always
Catch-up Among the Industrial Countries
FIGURE 10-8
There Has Been Catch-up among Industrial Countries

Learning Objective 10.4
Why Isn’t the Whole World Rich?
Catch-up: Sometimes, but Not Always
Are the Developing Countries Catching Up to the Industrial
Countries?
FIGURE 10-9
Most of the World Hasn’t
Been Catching Up

Learning Objective 10.4
Why Isn’t the Whole World Rich?
Why Don’t More Low-Income Countries
Experience Rapid Growth?
Failure to Enforce the Rule of Law
Property rights The rights individuals or firms have to the exclusive use of their property, including the right to buy or sell it.
Rule of law The ability of a government to enforce the laws of the country, particularly with respect to protecting private property and enforcing contracts.

Learning Objective 10.4
Why Isn’t the Whole World Rich?
Why Don’t More Low-Income Countries
Experience Rapid Growth?
Failure to Enforce the Rule of Law
FIGURE 10-10
The Rule of Law and Growth

Learning Objective 10.4
Why Isn’t the Whole World Rich?
Why Don’t More Low-Income Countries
Experience Rapid Growth?
Wars and Revolutions
Wars have made it impossible for countries such as Afghanistan, Angola, Ethiopia, the
Central African Republic and the Congo to accumulate capital or adopt new technologies.

Learning Objective 10.4
Why Isn’t the Whole World Rich?
Why Don’t More Low-Income Countries
Experience Rapid Growth?
Poor Public Education and Health
Many low-income countries have weak public school systems, so many workers are unable to read and write.
People who are sick work less and are less productive when they do work.
Low Rates of Saving and Investment
The low savings rates in developing countries contribute to a vicious cycle of poverty.

Learning Objective 10.4
Why Isn’t the Whole World Rich?
The Benefits of Globalization
FIGURE 10-11
Globalization and Growth

Learning Objective 10.5
Growth Policies
We have seen that even small differences in growth rates compounded over the years can lead to major differences in standards of living.
Therefore, there is potentially a very high payoff to government policies that increase growth rates.
Enhancing Property Rights and the Rule of Law
Improving Health and Education
Policies with Respect to Technology
Policies with Respect to Saving and Investment
Is Economic Growth Good or Bad?

How to increase the economy’s productive capacity over time.
Two definitions of economic growth:
The increase in real GDP , which occurs over a period of time.
The increase in real GDP per capita , which occurs over time.

=
(the share of each inhabitant of the GDP on average)
This definition is superior if
is desired.
China’s 2001 GDP was $1131 billion compared to
Kuwait’s $36 billion,
But per capita GDP’s were $890 and $18000 respectively.

Growth in real GDP does not guarantee growth in real GDP per capita .
If the growth in population exceeds the growth in real GDP, real
GDP per capita will fall (lower standards of living).
Expansion of total output relative to population results in:

Growth as a Goal
Growth is an important economic goal because it means more material abundance and ability to meet the economizing problem.
Arithmetic of Growth: Rule of 70
The “rule of 70” uses the absolute value of a rate of change, divides it into 70 , to tell us about the number of years it will take for some measure to double (in compound rates).

e.g.,
If growth rate = 3%. It will take 23 years to double GDP
Small changes in the rate of growth are important.
If the rate of growth increased to 4%. It will take about 18 years only to double GDP.
In USA with a $12.5 trillion GDP, the difference between the rate of 3% and 4% equals 125 billion.

Sources:
Increasing inputs of resources
Increasing productivity of resources productivity = real output per unit of input e.g., productivity of labor productivity of labor = real output / No. labor units
How can we improve productivity of labor??
Two thirds of growth in USA result from improved productivity. Only one-third of
U.S. growth comes from more inputs

The rate of growth of real GDP in Kuwait
1993 8702.5
1994 9453.2
1995 9583.4
1996 9323.9
1997 9435.2
7379.8
8113.9
9429.1
9206.7
7906.5
33.759
8.626
1.377
-2.708
1.194
1998 9733.2
1999 9255.2
9169.7
11356.7
3.158
-4.911
2000 9946.1 average
10445.7 7.465
5.995
War and liberation effect

Society can increase its real output growth by:
Increasing its inputs of resources (Quantity).
Increasing productivity of resources (Quality).
(Productivity: real output per unit of input)
Productivity rises with:
1) improvement in: health, training, education, and motivation of workers.
2) use of more and better machines and resources.
3) better organization and management of production.
4) reallocation of labor from less to more efficient firms.

Fluctuations in economic activity
Individual cycles vary substantially in duration and intensity:
- short cycle
- medium cycle
- long term cycle

Time

Phases of the Business Cycle
Four phases of the business cycle are identified over a several-year period.
A peak is when business activity reaches a temporary maximum with near/full employment and near full capacity output.
At peak:
Full employment
Real output is close to capacity
Prices likely to be high

A recession
There is a decline in total output, income, and employment, lasting six months or more .
It is marked by a widespread concentration of business activity in many sectors of the economy
Prices fall only if a depression occurs
(many prices are sticky )

A trough (recession or depression) is the bottom of the recession period. Output and employment bottom out at their lowest levels
A recovery is when output and employment are expanding toward the full-employment level. Price level may increase before full employment.

There are several theories about causation
Momentous innovations:
Major innovations may trigger new investment and/or consumption spending.
railroads, automobiles, and micro-chips, have great impact on investment spending and thus on output, employment and prices.
Contribute to variability of economic activity

Changes in productivity may be a related cause:
When productivity expands, the economy booms.
When productivity falls the economy recedes.
Too much money leads to inflationary boom
Too little money triggers recession

Most economists agree that the level of aggregate spending is important, especially changes on capital goods and consumer durables.
When total spending sinks, output, income and employment fall.
When total spending rises, output, income and employment rise.

Cyclical Impact: Durables and Nondurables
Durable goods output is more volatile than non-durables and services because spending on the latter usually cannot be postponed. Capital goods and consumer durables are affected the most.
In recessions, firms delay the purchase of new machines and equipments and consumers repair their old appliances.
In booms, firms replace their capital and consumers buy new appliances.
Nondurable consumer goods are little affected by recessions.