Chapter 15
How Economies
Grow
Learning Objectives
• Define economic growth.
• Explain why small differences in growth rates
matter so much.
• Outline why saving is important for economic
growth.
• Contrast inventions with innovations.
• Tell why improvement in secondary schooling
is so important for developing nations.
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15-2
Economic Growth
• Earlier you learned that the growth in
real GDP is often called economic
growth.
• However, when a nation grows
economically, its citizens must be better
off in at least some ways, usually in
terms of their material
well-being.
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15-3
Economic Growth (cont.)
• Economic growth occurs when there
are increases in per-capita output per
unit time period, usually per year.
Economic growth is measured by the
annual rate of change in per-capita real
GDP.
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15-4
International Example
• India has a total national output that is three
times as large as that of Switzerland.
• India’s population, though, is 125 times
greater than that of Switzerland.
• Thus, when we take into account the amount
of output that is available to the average
person, we can conclude that India is a
relatively poor country and Switzerland is a
relatively rich country.
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15-5
Economic Growth and
the Magic of Compounding
• Some countries grow and others do not.
You can see this in Table 15-1, next.
• There you see the annual average rate
of economic growth in selected
countries.
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Table 15-1: Per Capita Growth Rates
in Various Countries
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Small Differences in Growth
Matter
• A small difference in the rate of economic
growth may not matter for next year or the
year after, but it surely does matter over
longer periods.
• It all has to do with the power of
compounding.
• The difference of one percentage point
in our economic rate of growth over this
nation’s history could have lead to three times
our current standard of living.
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Compounding Example
• In 1626, Dutchman Peter Minuit arrived in
Manhattan, charged by the West India
Company with the task of administering the
struggling colony.
• Minuit purchased Manhattan Island from
Native American Indians for the now
legendary price of 60 guilders, or about $20.
That $20 compounded at 6 percent would
equal about $130 billion today, and at 7
percent about $5.8 trillion today.
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15-9
Saving: An Important Determinant
of Economic Growth
• Economic growth does not occur in a
vacuum. It is not some predetermined
fate of a nation.
• Rather, economic growth depends on
certain fundamental factors. One of the
most important factors that affect the
rate of economic growth and hence
long-term living standards is the rate of
saving.
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15-10
A Basic Economic Growth
Proposition
• To have more consumption in the future,
you have to consume less today and
save the difference between your
consumption and your after-tax income.
• On a national basis, this implies that
higher saving rates eventually mean
higher living standards in the long run,
all other things held constant.
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15-11
A Basic Economic Growth
Proposition (cont.)
• Saving is important for economic growth
because if all income is consumed each
year, there is nothing leftover for saving,
which could be used by businesses for
investment.
• If there is no investment in our capital
stock, there is little hope of economic
growth.
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15-12
A Basic Economic Growth
Proposition (cont.)
• Data shows that in general, nations that
have experienced high rates of saving
have had greater economic growth
rates than those that have not.
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15-13
Productivity Increases—It’s What
Economic Growth Is All About
• Labor productivity is normally
measured by dividing real GDP by the
number of workers or the number of
labor hours.
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Productivity Increases—It’s What
Economic Growth Is All About (cont.)
• Whenever average output produced per
worker during a specified time period
increases, we say that labor productivity
has increased.
• Clearly, there is a positive relationship
between economic growth and
increases in labor productivity.
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15-15
Separating Different Rates of
Growth of Production Inputs
• If you divide all resources into just
capital and labor, economic growth can
be defined as the cumulative
contribution to per capita real GDP
growth of three components:
– the rate of growth of capital,
– the rate of growth of labor, and
– the rates of growth of capital and labor
productivity.
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15-16
Growth in Technology
• Technology has grown erratically in the
United States and elsewhere.
Nonetheless, there are some startling
statistics about the growth in
technology.
• The greater the reward to those who
innovate, the more technological
advances we will get.
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Growth in Technology:
An Example
• Microprocessor speeds currently exceed
3,000 megahertz. By the year 2011, they will
exceed 12,000 megahertz.
• During the same period, the size of the
thinnest circuit line within a transistor will
decrease by 80 percent.
• By 2011, microchip plants will produce 1,500
chips a week for every person on earth
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15-18
Research and Development
• A certain amount of technological
advance results from research and
development (R&D) activities that have
as their goal the development of specific
new materials, new products, and new
machines.
• How much spending a nation devotes to
R&D can have an impact on its longterm economic growth.
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15-19
Innovation and Knowledge
• Innovation involves the transformation
of something new, such as an invention,
into something that benefits the
economy either by lowering production
costs or by providing new goods and
services.
• Historically, technologies have moved
relatively slowly from invention to
innovation to widespread use.
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The Importance of Human Capital
• Knowledge, ideas, and productivity are all
tied together. One of the threads is the
quality of the labor force.
• Increases in the productivity of the labor force
depend on increases in human capital.
• Human capital is the knowledge and skills
that people in the workforce acquire through
education, on-the-job training, and selfteaching.
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How You Can Invest in
Human Capital
• To increase your own human capital, you
have to invest by not working for pay while
you attend school.
• Society also has to invest in libraries and
teachers.
• According to modern economic growth
theorists, human capital is at least as
important as physical capital, particularly
when trying to explain international
differences in living standards.
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15-22
Schooling is Important
• Researchers have found that one of the
most effective ways that developing
countries can become developed is by
investing in secondary schooling.
• Teaching more children ages 12 to 18
may be more important than having a
large network of colleges and
universities in developing countries.
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15-23
Property Rights and
Entrepreneurship
• If you lived in a country where bank accounts
and businesses were periodically
expropriated by the government, how willing
would you be to leave your money in a
savings account or to invest in a business?
• You would be living in a political and
economic system in which your property
rights are not well defined and legally
supported.
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Property Rights and
Entrepreneurship (cont.)
• The more certain property rights are, the
more capital accumulation level will be, and
therefore there will be greater economic
growth.
• Well defined property rights have usually
been necessary for economic growth to
occur.
• Entrepreneurs will not take risks if they
believe that their rewards from taking risks
will be confiscated.
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Key Terms and Concepts
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compounding
economic growth
human capital
innovation
labor productivity
nationalization
property rights
research and development (R&D)
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