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Economic Growth
CHAPTER SEVENTEEN
ECONOMIC GROWTH
CHAPTER OVERVIEW
In Chapter 8 we looked at the impact of economic growth in general and concentrated on the causes of
short-run fluctuations in employment and price levels and on policies that might mitigate such
instability. The issue of long-run economic growth is equally important. Although punctuated by
periods of cyclical instability, economic growth in the United States has been impressive. For example,
during the last half century, real output increased 450 percent while population increased only 80
percent, to yield approximately a tripling of the goods and services available to the average American.
The discussion of growth in this chapter explores economic growth in more depth than in Chapter 8. We
question whether the United States is achieving a “new economy” which might deliver a stronger future
rate of growth. Finally, we explore both positive and negative aspects of growth.
WHAT’S NEW
The organizational structure and content remain largely intact, but there are a number of important
changes to note.
The chapter title has been shortened from “Economic Growth and the New Economy” to “Economic
Growth.” In the section now titled “The Productivity Acceleration: A New Economy?” the prospect of a
“new economy” is examined, particularly as it relates to productivity changes.
Table 17-1 has been replaced with growth accounting data from the Economic Report of the President.
A “Consider This” box (“Economic Growth Rates Matter!”) has been added to illustrate how even
seemingly small differences in growth rates can result in large differences in real GDP and real GDP per
capita. This piece appeared on the website in the previous edition under “Analogies, Anecdotes, and
Insights.”
There is a new “Last Word” on “Women and Economic Growth” (that appeared in Chapter 2 of the
previous edition).
INSTRUCTIONAL OBJECTIVES
After completing this chapter, students should be able to
1. Identify six main ingredients in economic growth.
2. Show economic growth using production possibilities analysis and aggregate demand-aggregate
supply analysis.
3. Describe the growth record of the U.S. economy since 1950, including two measures of its
long-term growth rates.
4. Identify six major factors that contributed to U.S. economic growth according to empirical studies.
5. List three primary reasons for productivity acceleration in the United States since 1995.
6. List five reasons for increasing returns during the period of productivity acceleration.
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7. Identify three macroeconomic implications of stronger productivity growth and more intense
global competition.
8. Evaluate the potential for the productivity acceleration to be a permanent phenomenon.
9. Identify and explain the arguments for and against economic growth.
10. Define and identify the terms and concepts at the end of the chapter.
COMMENTS AND TEACHING SUGGESTIONS
1. The record of U.S. economic growth is more meaningful if you can put it into comparative
perspective. World Bank publications such as the World Development Report or World Bank
Atlas give population and growth statistics for most countries.
2. Global Perspectives 17-1 gives an interesting (although not unfamiliar) comparison of academic
achievement of eighth-grade math and science scores. It may be useful to discuss how the U.S.
still manages to achieve solid economic growth and what numbers like these suggest for long-term
growth prospects.
3. An interesting source for debate on whether or not growth is desirable would be the classic, E. F.
Schumacher’s Small is Beautiful. Other books that touch on U.S. economic growth issues are
Lester Thurow’s Zero-Sum Society and Zero-Sum Solution and Wallace Peterson’s Our
Overloaded Economy. The many articles and books related to environmental issues highlight the
gap between rich and poor.
4. The information economy raises many questions about concepts we teach in economics. Two
excellent books are Information Rules and Blown to Bits. The January 1, 2000, issue of The Wall
Street Journal had an entire section entitled “Good-Bye Supply and Demand.”
5. To give students greater appreciation of the impact of technological change over the past 100
years, you may wish to share with them this “Concept Illustration” that previously appeared on the
website in the “Analogies, Anecdotes, and Insights” section.
CONCEPT ILLUSTRATION … Technological change and economic growth
Economist J. Bradford DeLong points out that technological change has brought forth goods and
services that would have been simply unimaginable a century ago.*
I believe there is…insight to be gained [on this matter by] examining Edward Bellamy’s (1887)
Looking Backward. Although the prose is wooden to our sensibilities, the book was a best-seller
in the late nineteenth century, because it gave a very hopeful vision of how economic growth
would bring us utopia.
The narrator goes forward in time from 1895 to 2000, and his host of the future asks, “Would
you like to hear some music? The narrator expects his host to play the piano—a social
accomplishment of upper-class women around 1900. Instead, the narrator is stupefied to find his
host “merely touched one or two screws,” and immediately the room “filled with music; filled,
not flooded, for by some means, the volume of the melody has been perfectly graduated to the
size of the apartment. ‘Grand!’ I cried. ‘Bach must be at the keys of that organ; but where is the
organ?’” He learns that his host has called the orchestra on the telephone.
In Bellamy’s late twentieth-century utopia you can dial up a live orchestra and then put it on the
speakerphone. You even have a choice of orchestras—there are four at any moment. Bellamy’s
narrator then says, “if we [in the nineteenth century] could have devised an arrangement for
providing everybody with music in their homes, perfect in quality, unlimited in quantity, suited
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to every mood, we would have considered the limit of human felicity [ecstasy] already attained
…”
What if someone were to take Edward Bellamy to Tower Records today? His heart would stop.
Yet we do not give thanks for our [CD players] and our CD collections for having brought us to
the limit of human felicity. We rarely think about them at all: we take them for granted ...
Modern economic growth has been so great as to carry us off the scale of measurement that past
generations could have imagined.
J. Bradford DeLong, “How Fast is Modern Economic Growth?” Economic Letter (Federal Reserve
Bank of San Francisco), October 16, 1998, pp. 1-2.
*
LECTURE NOTES
I.
Introduction
A. Two definitions of economics growth were given in Chapter 8.
1. The increase in real GDP, which occurs over a period of time.
2. The increase in real GDP per capita, which occurs over time. This definition is superior
if comparison of living standards is desired.
B. Growth has been impressive in capitalist countries during the past half century. Real GDP in
the U.S. increased by 450 percent.
C. This chapter explores economic growth in more depth than Chapter 8.
II.
Six Main Ingredients of Growth
A. Four supply factors relate to the ability to grow.
1. The quantity and quality of natural resources
2. The quantity and quality of human resources
3. The supply or stock of capital goods
4. Technology
B. Two demand and efficiency factors are also related to growth.
1. Aggregate demand must increase for production to expand.
2. Full employment of resources and both productive and allocative efficiency are
necessary to get the maximum amount of production possible.
III.
Production Possibilities Analysis (Figure 17-1)
A. Growth can be illustrated with a production possibilities curve (Figure 17-1), where growth
is indicated as an outward shift of the curve from AB to CD.
1. Aggregate demand must increase to sustain full employment at each new level of
production possible.
2. Additional resources that shift the curve outward must be employed efficiently to make
the maximum possible contribution to domestic output.
3. For the economy to achieve the maximum increase in value, the optimal combination of
goods must be achieved (allocative efficiency).
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B. Focus on the supply side is illustrated in Figure 17-2, where growth depends on labor inputs
multiplied by labor productivity.
1. Increased labor inputs depend on size of population and labor force participation rate
(the percent of population actually in the labor force).
2. Productivity is determined by technological progress, the availability of capital goods,
quality of labor itself, and efficiency with which inputs are allocated, combined, and
managed.
C. Aggregate demand-aggregate supply framework can also be used to illustrate growth, as seen
in Figure 17-3. Aggregate supply shifts outward with economic growth, and in recent
decades aggregate demand has shifted outward by an even greater amount. Nominal GDP
rises faster than real GDP. (Key Question 3)
D. An extended AD-AD model is shown in Figure 17-4 where short-term and long-term
aggregate supply are differentiated.
1. Long-run potential output is shown at Q1. It depends on resources and productive
efficiency.
2. If potential output increases, the long-run supply curve shifts from ASLR1 to ASLR2.
3. If aggregate demand rises from AD1 to AD2, real output rises to Q2 and prices to P2.
4. At P2 there will be a different short-run AS curve, AS2.
5. The result is some mild inflation and increases in real GDP.
IV.
Growth Record of the United States (Table 17-5)
A. Real GDP has increased more than six-fold since 1950, and real per capita GDP has risen by
a multiple of three.
B. Rate of growth records shows that real GDP has grown 3.1 percent per year since 1948 and
real GDP per capita has grown about 2 percent per year. In last four years of the 20th
century, U.S. economic growth surged and averaged more than 4 percent per year. But the
arithmetic needs to be qualified.
1. Growth doesn’t measure quality improvements.
2. Growth doesn’t measure increased leisure time.
3. Growth doesn’t take into account adverse effects on the environment.
4. International comparisons are useful in evaluating U.S. performance. For example,
Japan has grown more than twice as fast as the U.S. since 1948, but less in the past
decade.
V.
Accounting for growth is an attempt to quantify factors contributing to economic growth.
A. More labor input is one source of growth. The labor force has grown by about 2 million
workers per year for past 25 years and accounts for about one-third of total economic growth.
B. Technological advance, the most important factor, has been estimated to contribute to about
26% of the U.S. growth record since 1929.
C. Increases in quantity of capital are estimated to have contributed 18% to economic growth in
the U.S. since 1929.
D. Education and training improve the quality of labor. (See Figure 17-6 and Table 17-1.)
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E. Improved resource allocation and economies of scale also contribute to growth and explain
about 12% of total growth.
1. Improved resource allocation has occurred as discrimination disappears and labor moves
where it is most productive, and as tariffs and other trade barriers are lowered.
2. Economies of scale occur as the size of markets and firms that serve them have grown.
F. Other factors influence growth and are more difficult to measure.
1. The social and cultural environment and political stability are “growth friendly” in the
U.S.
a. Respect for material success provides incentive to increase incomes.
b. The market system rewards actions that increase output.
c. Property rights and the legal system encourage growth.
2. Positive attitudes toward work and the flow of energetic immigrants also add to growth.
VI.
The Productivity Acceleration: A New Economy? (Figure 17-7)
A. Improvement in standard of living is linked to labor productivity – output per worker per
hour.
B. The U.S. is experiencing a resurgence of productivity growth based on innovations in
computers and communications, coupled with global capitalism. Since 1995 productivity
growth has averaged 2.8% annually – up from 1.4% over 1973-95 period. The “Rule of 70”
projects real income will double in 23 years rather than 50 years.
C. Much of the recent improvement in productivity is due to “new economy” factors.
1. Microchips and information technology are the basis for improved productivity. Many
new inventions are based on microchip technology.
2. New firms and increasing returns characterize the new economy.
a. Some of today’s most successful firms didn’t exist 25 years ago: Dell, Compaq,
Microsoft, Oracle, Cisco Systems, America Online, Yahoo, and Amazon.com are
just a few of many.
b. Economies of sale and increasing returns in new firms encourage rapid growth.
3. Sources of increasing returns include
a. More specialized inputs.
b. The ability to spread development costs over large output quantities since marginal
costs are low.
c. Simultaneous consumption by many customers.
d. Network effects make widespread use of information goods more valuable as more
people use the products.
e. Learning increases with practice.
4. Global competition encourages innovation and efficiency.
D. Macroeconomic outcomes include increases in aggregate supply (shift to right). (See Figure
17-3.)
E. Faster growth without inflation is possible with higher productivity.
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F. The natural rate of unemployment seems to be lower (4.0 – 5.0%).
G. Federal revenues increase with economic growth; a 1995 deficit of $160 billion became a
$167 billion surplus in 2000.
H. Skepticism about long-term continued growth remains, and only time will tell.
VII.
Is Growth Desirable and Sustainable?
A. An antigrowth view exists.
1. Growth causes pollution, global warming, ozone depletion, and other problems.
2. “More” is not always better if it means dead-end jobs, burnout, and alienation from one’s
job.
3. High growth creates high stress.
B. Others argue in defense of growth.
1. Growth leads to an improved standard of living.
2. Growth helps to reduce poverty in poor countries.
3. Growth has improved working conditions.
4. Growth allows more leisure and less alienation from work.
6. Environmental concerns are important, but growth actually has allowed more sensitivity
to environmental concerns and the ability to deal with them.
C. Is growth sustainable? Yes, say proponents of growth.
1.
Resource prices are not rising.
2. Growth today has more to do with expansion and application of knowledge and
information, so is limited only by human imagination.
VIII.
LAST WORD: Women and Economic Growth
A. There has been an increase in the number of women who are working. This has had the
effect of shifting the production possibilities curve outward.
B. Whereas 40% of the women worked in 1965, 60% of the women are now working part time
or full time.
C. There are a number of reasons for this change.
1. An increase in women’s wage rates.
2. Greater access to jobs.
3. Changes in preferences and attitudes.
4. Declining birth rates.
5. Increasing divorce rates.
6. Slower growth in male wages.
ANSWERS TO END-OF-CHAPTER QUESTIONS
17-1
(Key Question) What are the four supply factors of economic growth? What is the demand
factor? What is the efficiency factor? Illustrate these factors in terms of the production
possibilities curve.
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The four supply factors are the quantity and quality of natural resources; the quantity and quality
of human resources; the stock of capital goods; and the level of technology. The demand factor
is the level of purchases needed to maintain full employment. The efficiency factor refers to
both productive and allocative efficiency. Figure 17-1 illustrates these growth factors by
showing movement from curve AB to curve CD.
17-2
Suppose that Alpha and Omega have identically sized working-age populations, but that annual
hours of work are much greater in Alpha than in Omega. Provide two possible explanations.
One explanation might be that Omega’s labor force is underemployed, producing at a point
inside the production possibilities curve. Another explanation could be that the two populations
have different attitudes and preferences about work and leisure, with Omega workers placing a
higher value on leisure than those in Alpha.
17-3
Suppose that work-hours in New Zombie are 200 in year 1 and productivity is $8. What is New
Zombie’s real GDP? If work-hours increase to 210 in year 2 and productivity rises to $10, what
is New Zombie’s rate of economic growth?
NZ’s GDP in year 1 is $1600; GDP in year 2 is $2100.
The rate of growth is (2100-1600)/1600 or .3125 =31.25% (assumes constant prices).
17-4
What is the relationship between a nation’s production possibilities curve and its long-run
aggregate supply curve? How does each relate to the idea of a New Economy?
The supply factors that shift the production possibilities curve outward and explain economic
growth are the same factors that shift its long-run aggregate supply curve rightward. This is
shown in Figure 17-3 in the text. The new economy has hastened these shifts by improving
technology and the efficiency factor. These, in turn, have caused businesses to invest in new
capital and have made worker quality better as new skills are learned.
17-5
(Key Question) Between 1990 and 2002 the U.S. price level rose by about 38 percent while its
real output increased by about 41 percent. Use the aggregate demand-aggregate supply model to
illustrate these outcomes graphically.
In the graph shown, both AD and AS expanded over the 1990-2002 period. Because aggregate
supply increased as well as aggregate demand, the new equilibrium output rose at a faster pace
than did the price level. P2 is 38% above P1 and GDP2 is 41% greater than GDP1.
Price
AS1
Level
AS2
P2
P1
AD1
GDP1
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GDP2
AD2
Real GDP
Economic Growth
17-6
(Key Question) To what extent have increases in U.S. real GDP resulted from more labor inputs?
From higher labor productivity? Rearrange the following contributors to the growth of real GDP
in order of their quantitative importance: economies of scale, quantity of capital, improved
resource allocation, education and training, technological advance.
The U.S. labor force grew by an average of about 1.7 million workers per year for each of the
past 25 years, and this explains much of the growth in real GDP. From 1990-2002, higher labor
productivity accounted for 68 percent of the 3 percent average annual growth Other factors have
also been important. Refer to Table 17-1. Factor importance in descending order: (1)
Technological advance—the discovery of new knowledge that results in the combining of
resources in more productive ways. (2) The quantity of capital. (3) Education and training. (4)
Economies of scale. (5) Improved resource allocation.
17-7
True or false? If false, explain why.
a. Technological advance, which to date has played a relatively small role in U.S. economic
growth, is destined to play a more important role in the future.
b. Many public capital goods are complementary to private capital goods.
c. Immigration has slowed economic growth in the U.S.
(a) The first part is false because technology has played the most important role in U.S.
economic growth of any growth factor. However, the second part of the statement is
probably true.
(b) True.
(c) False; immigration has been a source for an expanded labor force and also for expansion in
aggregate demand.
17-8
Explain why there is such a close relationship between changes in a nation’s rate of productivity
growth and changes in its average real hourly wage.
Real hourly wage average represents the average purchasing power of the wage each worker
receives. Purchasing power refers to the amount of output that can be obtained with that wage.
If output per worker is not increasing, then the amount of output available per capita for workers
to buy will not be growing either. In other words the “real” wage changes only if there is an
increase in productivity. Nominal wages don’t represent purchasing power.
17-9
(Key Question) Relate each of the following to the New Economy:
a. The rate of productivity growth
b. Information technology
c. Increasing returns
d. Network effects
e. Global competition
Each of the above is a characteristic of the New Economy. The rate of productivity growth has
grown substantially due to innovations using microchips, computers, new telecommunications
devices and the Internet. All of these innovations describe features of what we call information
technology, which connects information in all parts of the world with information seekers. New
information products are often digital in nature and can be easily replicated once they have been
developed. The start-up cost of new firms and new technology is high, but expanding production
has a very low marginal cost, which leads to economies of scale – firms’ output grows faster than
their inputs. Network effects refer to a type of economy of scale whereby certain information
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products become more valuable to each user as the number of buyers grows. For example, a fax
machine is more useful to you when lots of other people and firms have one; the same is true for
compatible word-processing programs. Global competition is a feature of the New Economy
because both transportation and communication can be accomplished at much lower cost and
faster speed than previously which expands market possibilities for both consumers and
producers who are not very limited by national boundaries today.
17-10 Provide three examples of products or services that can be simultaneously consumed by many
people. Explain why labor productivity greatly rises as the firm sells more units of the product or
service, and explain why the higher level of sales greatly reduces the per-unit cost of the product.
Text examples include films, CD entertainment, television programs, software programs, and
Internet information. Labor productivity rises with some of these products when they are used as
inputs because sharing compatible software programs, Internet information, and the same video
training programs, for example, can expand output potential for many workers who benefit from
the effects of using or learning from the information simultaneously.
Production of information goods has a high start-up or development cost, but additional units can
be produced at little or no cost. Therefore, as more units are produced, the denominator rises,
but the total cost won’t rise much and the cost per unit, therefore, will fall.
17-11 What is meant when economists say that the U.S. economy has a “higher safe speed limit” than it
had previously? If the New Economy has a higher safe speed limit, what explains the series of
interest rate hikes engineered by the Federal Reserve in 1999 and 2000?
If productivity growth (output per worker) is fueling economic growth, then the economy is able
to grow more rapidly without experiencing increasing production costs. Cost per unit does not
increase if total output is growing as fast as increases in input costs. The increased efficiency of
the New Economy has allowed the economy to grow without increasing resource costs
substantially. However, the Federal Reserve probably bases its concern about inflation on past
history and declining unemployment is usually a signal that inflationary pressures will heat up.
Therefore, the Fed acted to dampen these pressures; but it may have raised interest rates too high
and slowed the economy when inflation was not so great a threat in the new environment.
17-12 Productivity often rises during economic expansions and falls during economic recessions. Can
you think of reasons why? Briefly explain. (Hint: Remember that the level of productivity
involves both levels of output and levels of labor input.)
Productivity would be likely to rise during economic expansions because the low rate of
unemployment would encourage the more intensive use of existing plant and equipment and
current workforce. Worker productivity would be likely to fall during recessions because
employers would be reluctant to discharge valuable workers until absolutely necessary.
17-3
(Last Word) Which two of the six reasons listed in the Last Word do you think are the most
important in explaining the rise in participation of women in the workplace? Explain your
reasoning. How does the rising labor-force participation rate of women relate to economic
growth?
A poll taken in a class of 60 college freshman gave the first three reasons (women's rising wage
rates, expanded job accessibility, and changing preferences and attitudes) nearly all the votes.
Each of these explanations received about one-third of the votes. Surprisingly, not a single
student voted for “declining birth rates” as a reason for the rise in the number of women in the
workforce. The consensus of the class was that the last three explanations (declining birth rates,
rising divorce rates, and stagnating male earnings) were the effects, rather than the cause of more
women joining the work force. Because wage rates are higher the opportunity cost of raising
children has risen. Women have chosen to bear fewer children, because they are now relatively
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more expensive. Similarly, women who have a higher earning capacity find the opportunity cost
of getting a divorce reduced. Finally, male earnings may have stagnated partially because of the
entrance of large numbers of well-educated women into the work force, increasing the
competition for the available jobs.
The increase in female labor force participation fuels growth by expanding the labor input. This
would be represented graphically has an outward expansion of the production possibilities curve
or a rightward shift of the aggregate supply curve.
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