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Economic Growth
CHAPTER 15
ECONOMIC GROWTH
CHAPTER OVERVIEW
In Chapter 6 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 Canada has been impressive.
The discussion of growth in this chapter explores economic growth in more depth than in Chapter 6. We
question whether Canada 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.
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 “The Kyoto Protocol and Economic Growth in Canada” .
INSTRUCTIONAL OBJECTIVES
After completing this chapter, students should be able to understand:
1.
2.
3.
4.
5.
6.
About the ingredients of economic growth.
About production possibility analysis.
About Canada’s economic growth rates.
About sources of Canada’s economic growth rates.
About productivity growth.
About the pros and cons of economic growth.
COMMENTS AND TEACHING SUGGESTIONS
1.
The record of Canada’s economic growth is made more meaningful if you can take time to put it in
comparative perspective. Global Perspectives 15-1 is a start, but World Bank publications such as
the World Development Report and World Bank Atlas give population and growth statistics for
most countries of the world (World Bank, 1818 H Street, N.W., Washington, DC 20433). The
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contrast between the industrialized and developing countries in these reports is very dramatic and
helps students appreciate the importance of economic growth.
2.
An interesting source for debate on whether or not growth is desirable would be E.F. Schumacher’s
Small Is Beautiful. Other books that touch on 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 that emerged from the Environmental Summit in Brazil in June 1992 will
also be relevant to any discussion on the “growth vs. the environment” controversy.
3.
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-By Supply and Demand.”
4.
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 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.
*
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LECTURE NOTES
I.
Introduction
A. Two definitions of economics growth were given in Chapter 6.
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. This chapter explores economic growth in more depth than Chapter 6.
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, and
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 15-1)
A. Growth can be illustrated with a production possibilities curve (Figure 15-1), 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. And for economy to achieve the maximum increase in monetary value, the optimal
combination of goods must be achieved (allocative efficiency).
B. Focus on the supply side is illustrated in Figure 15-1, where growth depends on labour inputs
multiplied by labour productivity.
1. Increased labour inputs depend on size of population and labour force participation rate
(the percent of population actually in the labour force).
2. Productivity is determined by technological progress, the availability of capital goods,
quality of labour 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 15-3. 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 5)
D. Extended AD-AS model is shown in figure 15-4 where short-term and long-term aggregate
supply are differentiated in Figure 15-4.
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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 growth.
IV.
Productivity Growth and the New Economy (Figure 15-7)
A. Improvement in standard of living is linked to labour productivity – output per worker per
hour.
B. Canada is experiencing a resurgence of productivity growth based on innovations in
computers and communications, coupled with global capitalism.
C. Much recent improvement in productivity is due to “new economy” factors such as:
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. Economies of sale and increasing returns in new firms encourage rapid growth. (See
Table 15-1)
3. Sources of increasing returns include:
a. More specialized inputs.
b. Ability to spread development costs over large output quantities since marginal costs
are low.
c. Simultaneous consumption of many customers at same time.
d. Network effects make widespread use of information goods more valuable as more
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
15-3.
E. Faster growth without inflation is possible with higher productivity.
F. The natural rate of unemployment seems to be lower.
G. Skepticism about long-term continued growth remains.
V.
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.
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B. Others argue in defense of growth.
1. Growth leads to improve 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.
ANSWERS TO END-OF-CHAPTER QUESTIONS
15-1
(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.
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 18-1 illustrates these growth factors by showing
movement from curve AB to curve CD.
15-2
Suppose that Alpha and Omega have identically sized working aged populations, but that annual
work hours are much greater in Alpha than in Omega. Provide two possible explanations.
One explanation might be that Omega’s labour 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.
15-3
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
Rate of growth is (2100-1600)/1600 or .3125 =31.25% (assumes constant prices)
15-4
What is the relationship between a nation’s production possibilities curve and its long-run
aggregate supply curve? How do each relate to the idea of a New Economy?
The same 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 15-3 in the text. The new economy has hastened these shifts by
improving technology and the efficiency factor. These, in turn, have caused businesses new
invest in new capital and have made worker quality better as new skills are learned.
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Economic Growth and the New Economy
15-5
(Key Question) Between 1990 and 1999 the Canadian price level rose by about 20 percent while
its real output increased by about 33 percent. Use the aggregate demand-aggregate supply model
to illustrate these outcomes graphically.
In the graph shown, both AD and AS expanded over the 1990-1999 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 20% above P1 and GDP2 is 33% greater than GDP1. Note that it
is also possible that in early 1990s when unemployment was above natural rate that some of the
expansion of AD took place in the horizontal portion of AS curve, but that is not the situation
depicted here.
15-6
(Key Question) To what extent have increases in Canada’s real GDP been the result of more
labour inputs? Of increasing labour productivity? Discuss the factors that contribute to
productivity growth in order of their quantitative importance.
Refer to Table 15-2. Productivity increasing factors 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. Since 1940 the
proportion of those in the labour force with a high school education has doubled from 40 to 80
percent. And those with a college or university education have more than doubled from under 10
percent to over 20 percent. (4) Economies of scale and (5) improved resource allocation. Workers
have been moving out of lower productivity jobs to higher productivity jobs. Part of this is
associated with the increased efficiency often derived from production in larger plants, in which
specialization of labour and productivity-increasing methods are possible.
15-7
True or false? If false, explain why.
a. Technological advance, which to date has played a relatively small role in Canadian
economic growth, is destined to play a more important role in the future.
b. Many public capital goods are complementary to private capital goods.
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c. Immigration has slowed economic growth in Canada.
(a) Is false at the beginning because technology has played the most important role in Canada’s
economic growth of any growth factor. However, the second part of the statement is
probably true.
(b) Is true.
(c) False, immigration has been a source for expanded labor force and labor inputs and also for
expansion in aggregate demand.
15-8
How do you explain the close correlation between changes in the rate of productivity growth and
changes in real wage rates? Discuss the relationship between productivity growth and inflation.
The real income of a nation and what it produces are the same thing. If the real income of workers
were to rise for a considerable length of time at a faster rate than the rate at which they were
increasing production (their rate of productivity growth), the workers’ income would equal the
entire national output; there would be nothing for the other factors of production. Long before this
happened, there would be massive unemployment, as entrepreneurs cut back production rather
than continue in the face of continually falling profits. Indeed, it is noteworthy that whenever
wages do increase considerably as a proportion of the national income—which means real wages
have been increasing faster than productivity growth—increasing unemployment follows.
In the long run, the only way for labour to get more products is to produce more products. If
labour gets a nominal (money) wage increase without producing more (that is, without increasing
productivity), then to maintain their share of the national income, employers must raise prices.
This means inflation. In the long run, if labour gets a 6 percent nominal wage increase but has
only had a 2 percent productivity increase, the result will be 4 percent inflation, and labour’s real
wage increase will be 2 percent and equal to the productivity increase.
15-9
(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
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.
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Economic Growth and the New Economy
15-10 Provide three examples of products or services that can be simultaneously consumed by many
people. Explain why labour 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, internet
information. Labour 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 the more units that are produced, the denominator
rises, but the total cost won’t rise much and the cost per unit, therefore, will fall.
15-11 What is meant when economists say that the Canadian economy has a “higher safe speed limit”
than previously? If the New Economy has a higher safe speed limit, what explains the series of
interest rate hikes engineered by the Bank of Canada in 1999 and 2000?
If productivity growth (output per worker) is fuelling 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.
15-12 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 labour 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.
15-13 Do you think economic growth is desirable? Explain your position on this issue.
Either a “yes” or “no” answer is acceptable here. On the antigrowth side, there are the arguments
that growth results in pollution, global warming, ozone depletion, and other environmental
problems. Poverty and discrimination continue to be problems despite impressive growth records
in Canada. Growth produces more goods but a decline in the quality of life for many in terms of
worker burnout, alienated employees, and insecurity as new technology creates job displacement.
High stress can impair physical and mental health.
On the pro-growth side, the primary argument is that living standards improve and lifestyles are
better for the vast majority. Growth enables a society to improve the nation’s infrastructure,
which enhances the ability to care for all, including the less fortunate. And ironically, growth may
make environmental protection more possible rather than less. Workers are better off in growing
economies with improved working conditions, more leisure, and more time for self-fulfilment.
15-14 (The Last Word) Visit the Government of Canada website on climate change at
http://www.climatechange.gc.ca/english/issues/how_will/fed_world.shtml. What diseases are
likely to spread in Canada from other parts of the world as a result of global warming? Will
spreading of such diseases have an economic impact?
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Economic Growth
According to the federal government report, diseases such as malaria and dengue could spread
from tropical areas to other parts of the world, presumably including Canada. If that should
happen, there certainly would be economic costs, as preventative measures would have to
implemented in Canada to protect its citizens. Canadians that were infected would miss work and
impose costs on our national health care system.
Consider This
Go to the Central Intelligence Agency’ World Fact Book website at
http://www.cia.gov/cia/publications/factbook/geos/ca.html, and select the following countries,
one at a time, from the drop-down menu, and then click “Economy”: Canada, the U.S., China,
and Singapore. Which of these countries had the fastest growth rate?
Although growth rates vary from year to year, China will probably have the most rapid growth
rate in any given year.
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