Download Lecture 1 - UTA Economics

© 2010 Jane Himarios, Ph.D.
Lecture 7
Chapter 7: Economic Growth
Economic growth rate = ((Real GDPlatest period – Real GDPearlier period )/Real
GDP earlier period) x 100
1.
Economic growth is desirable because it raises our standard of living.
2.
GDP
Go to https://www.cia.gov/library/publications/the-worldfactbook/rankorder/2001rank.html to see GDP for 232 countries. Why do you
think GDP is different in different countries?
3.
GDP cartogram
http://www-personal.umich.edu/~mejn/cartograms/ (scroll down)
4.
Population cartogram
http://www-personal.umich.edu/~mejn/cartograms/ (scroll down)
5.
Per capita GDP
Equation 1: Per capita GDP = GDP ÷ population
This equation shows that when GDP grows faster than the population, our
standard of living will rise (and vice versa). To see rank order per capita GDP for
232 countries go to https://www.cia.gov/library/publications/the-worldfactbook/rankorder/2004rank.html.
6.
Wealth growth rates
http://www.sasi.group.shef.ac.uk/worldmapper/display.php?selected=171
7.
Why do economic growth rates matter?
Different growth rates lead to widely different standards of living.
Rule of 72: To calculate the time required for any variable to double, divide its
percentage growth rate into 72.
Example: If a country’s growth rate = 2%, then its real GDP will double in 72/2 =
36 years.
Go to https://www.cia.gov/library/publications/the-worldfactbook/rankorder/2003rank.html and calculate how long it will take the U.S.’s
real GDP to double at its current growth rate. Compare this with the countries
with the highest and lowest positive growth rates shown.
© 2010 Jane Himarios, Ph.D.
Classical Model of Growth
Growth depends on technology, the amount of capital available, and the
productivity of labor.
Aggregate production function: Q = Af(K,L)
where
Q = output
A = technology
f = a function that relates output to inputs of capital and labor
K = capital resources (including land and entrepreneurship)
L = labor resources
and where
Q increases when A, K, or L increases.
Describe what will happen to output if:
1. the capital-to-labor ratio rises
2. the quality of the labor force improves
3. technology improves
Modern Growth Theory
Many innovations developed by individual firms have public good aspects; some
benefits spill over to the economy at large.
Examples: just-in-time inventory systems, Netscape’s Internet browser
Other Drivers of Economic Growth
Some things don’t show up in the aggregate production function, but are still
important drivers of growth:
1. Public Capital (roads, damns, power plants and transmission lines,
telecommunications networks, schools and universities)
2. The System for Protection of Property Rights (are ownership rights
recognized?)
3. The System for Contract Enforcement (are ownership rights and contracts
enforced?)
4. The Financial System (is the financial system stable?)
5. Freedom to trade with foreigners
Notice that government policies affecting these things will affect economic growth
© 2010 Jane Himarios, Ph.D.
and our standard of living! Pro-growth government policies can raise our
standard of living.
Important point: Clearly assigned and protected property rights help spur
economic growth.
Think about what might happen in these two situations:
1. You consider spending $10 million developing a new computer chip. The
government will allow you to patent your chip for 7 years (the government will
award you with the property right to the chip). You know that if other
manufacturers copy your formula, you can sue and the government will shut
them down. This will allow you to recoup your initial investment and maybe make
a profit.
2. You consider spending $10 million developing a new computer chip. There are
no patents. You know that if other manufacturers copy your chip, there is nothing
you can do, because your government does not award property rights, or enforce
them. If others copy your computer chip you might not be able to recoup your
initial investment. If you spend $10 million you probably won’t be able to recoup
your initial investment or make a profit.
In which situation are you more likely to spend $10 million to develop the new
chip? Situation #____
Therefore, in which situation is economic growth more likely to occur? Situation #
____
Go to http://rru.worldbank.org/businessplanet/ to see how easy (or hard) it is to
do business in 178 countries. Click on the green flag for the U.S. Compare our
results with a country with a yellow or red flag. Compare the results with those
from the CIA factbook results for GDP and GDP growth.
Go to www.bls.gov to see how productivity in the U.S. has changed this year and
over the last 10 years (see the right side of the screen and scroll down).
© 2010 Jane Himarios, Ph.D.
More about the Classical Model of Growth
J.B. Say believed that “production creates demand sufficient to purchase all
goods and services produced.” If Say’s Law is valid, then people will spend
enough money to buy all of the stuff that is produced.
If everything that is produced in our economy gets purchased, it will help to keep
the economy at full employment.
We will use the circular flow chart to show that the level of spending in our
economy is important to the health of our economy.
Real GDP = C + I + G + NX
Foreign
Countries
Product
Markets
Firms
Government
Households
Banks
Resource
Markets
There are three progressively more realistic stories we can use the circular flow
chart to tell. They all show that the level of spending is important and describe
the classical view that there will always be enough spending to keep us at full
employment
Simple classical story: People will spend all of their income.
More complicated classical story: People will spend part of their income and
save part of their income, but interest rate flexibility will insure that the money
saved by consumers will be spent on investment goods by firms. Total
expenditures will be sufficient to purchase all goods and services produced. In
the Classical view, saving and investment both depend on the interest rate.
Even more complicated classical story: People also spend part of their income
for foreign goods and use part of their income to pay taxes. But that money flows
back into the economy when foreigners buy our exports and when the
government buys government goods.
© 2010 Jane Himarios, Ph.D.
According to classical economists, the competitive interaction of the product
market, the labor market, and the capital market kept the economy operating
near full employment.
Price
Real Wage
Interest Rate
S
SLabor
D
DLabor
Output
Labor
The Product Market
The Labor Market
Saving
Inv.D
Investment
The Loanable Funds
Market
Loanable Funds (Capital) markets:
Another name for the saving curve is “the supply of loanable funds.”
Another name for the investment demand curve is “the demand for loanable
funds.”
If savings > investment demand then the interest rate will fall.
If savings < investment demand then the interest rate will rise.
© 2010 Jane Himarios, Ph.D.
Price
Real Wage
Interest Rate
S
SLabor
D
DLabor
Output
Labor
The Product Market
The Labor Market
Saving
Inv.D
Investment
The Loanable Funds
Market
Exercise #1: Classical view on savings: it isn’t a problem
1. Start in equilibrium in all three markets.
2. Show what will happen if people decide to save more:
a. Savings increases
b. Demand for products decreases
c. The interest rate will fall
3. Show what will happen when the interest rate falls:
a. Firms will borrow more investment funds to spend.
b. Demand for products increases, offsetting the decrease in 2c, above.
Exercise #2: Classical view on unemployment: it won’t persist
1. Start with a high wage rate so that there is unemployment.
2. Show that a surplus of labor puts downward pressure on wages, moving the
market back to equilibrium.
Classical conclusion: Anyone unemployed is simply unwilling to work at the
equilibrium real wage.