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Economic Growth
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The Nature of Growth
• Economic growth refers to increases
in the output (real GDP) – an expansion
of production possibilities.
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Two Types of Growth
• The short run — increased capacity
utilization
• The long run — expanded capacity
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Short-Run Changes in Capacity
Use
• The easiest kind of growth comes from
the increased use of our productive
capacity.
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Short-Run Changes in Capacity
Use
• We do not always take full advantage of
our productive capacity.
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Short-Run Changes in Capacity
Use
• Productive capacity is illustrated by the
production possibilities curve.
– Production possibilities are the alternative
combinations of final goods and services
that could be produced in a given time
period with all available resources and
technology.
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INVESTMENT GOODS
(quantity per year)
Short-Run Growth: Increased
Capacity Utilization
0
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B
A
CONSUMPTION
GOODS (quantity per
year)
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Long-Run Changes in Capacity
• To achieve large and lasting increases
in output, the production possibilities
must be pushed outward.
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Long-Run Changes in Capacity
• Economists tend to define economic
growth in terms of changes in potential
GDP.
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INVESTMENT GOODS
(quantity per year)
Long-Run Growth: Expanded
Capacity
0
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C
B
A
CONSUMPTION GOODS
(quantity per year)
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Aggregate Supply Focus
• Economic growth is possible only if the
AS curve shifts right.
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Supply-Side Focus
DETERMINANTS
OUTCOMES
Jobs
Internal market
forces
AS
Prices
External shocks
Growth
Policy levers:
fiscal policy
monetary policy
supply-side policy
Output
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AD
International
balances
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Nominal vs. Real GDP
• Economic growth refers to increases
in real GDP.
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Nominal vs. Real GDP
• Nominal GDP is the total value of
goods and services produced within a
nation’s borders, measured in current
prices.
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Nominal vs. Real GDP
• Real GDP is the inflation-adjusted value
of GDP; the value of output measured in
constant prices.
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The GDP Growth Rate
• Growth rate is the percentage change
in real GDP from one period to another.
Growth Rate
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=
change in real GDP
base period GDP
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The GDP Growth Rate
• Challenge for the future is to maintain
higher rates of economic growth.
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GROWTH RATE (percent per year
Recent U.S. Growth Rates
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0
-1.0
-2.0
-3.0
1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004
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The Exponential Process
• Even one year of “low” growth implies
lost output.
• Economic growth is a continuing
process.
• Gains made in one year accumulate in
future years.
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GDP per Capita: A Measure of
Living Standards
• GDP per capita — total GDP divided by
total population.
• It is average GDP.
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GDP per Capita: A Measure of
Living Standards
• Growth in GDP per capita is attained
only when growth of output exceeds
population growth.
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GDP per Capita: A Measure of
Living Standards
• U.S. GDP per capita has more than
doubled since Ronald Reagan was
president.
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The History of World Growth
$6,000
5,000
4,000
3,000
2,000
1,000
0
1000
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1500
1820
1995
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The Rule of 72
• Small differences in annual growth rates
cumulate into large differences in GDP.
• Seventy-two divided by the growth rate
equals the number of years it takes to
double.
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The Rule of 72
Growth Rate
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
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Doubling Time (years)
Never
144
72
48
36
29
24
21
18
16
14
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GDP per Worker
• GDP per worker is a measure of
productivity
• Average workers today produce nearly
twice as much as their parents.
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GDP per Worker
• The U.S. labor force grew faster than
the population during the 1990s.
– The labor force includes all persons over
age sixteen who are either working for pay
or actively seeking paid employment.
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GDP per Worker
• The U.S. employment rate also
increased.
– The employment rate is the proportion of
the population that is employed.
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GDP per Worker
• If productivity is increasing, then per
capita GDP is likely to rise as well.
– Productivity is measured as output per
unit of input, such as a labor hour.
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Productivity Gains
Average annual productivity increase 1990-99
1.8
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2.0
2.5
2.6
2.7
4.1
4.2
5.3
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Sources of Productivity Growth
• Sources of productivity gains include:
– Higher skills
– More capital
– Improved management
– Technological advance
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Labor Quality
• As education and training levels rise, so
does productivity.
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Capital Investment
• Capital investment is a prime
determinant of productivity and growth.
– Investment refers to expenditures on new
plant and equipment in a given time period,
plus changes in business inventories.
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Average Annual Growth Rate of
Labor, Capital, and Productivity
Period
1959-65
1965-69
1969-73
1973-79
1979-85
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Annual Percentage Change in
Output per
Labor Stock Capital Stock
Labor Hour
0.9
3.8
3.3
1.2
4.1
2.2
0.4
3.5
2.6
1.6
2.5
0.8
1.6
2.2
0.9
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Management
• Entrepreneurship and the quality of
continuing management are major
determinants of economic growth.
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Management
• There is a potential conflict between
short-term profits and long-term
productivity gains.
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Management
• Managers must develop personnel
structures and incentives that make
employees want to contribute to
production.
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Research and Development
•
•
•
•
Scientific research
Product development
Innovations in production technique
Development of management
improvements
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Policy Levers
• Government policies can have a major
impact on whether, and how far, the
aggregate supply curve shifts.
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Education and Training
• Government spending on education and
training has two payoffs:
– It stimulates the economy in the short run.
– It increases the long-run capacity to
produce.
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Immigration Policy
• The quality and quantity of labor are
affected by immigration policy.
– Direct contributor to outward shift of
production possibilities.
– Recent immigrants have lower educational
level than native-born Americans.
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Investment Incentives
• Tax policy is not only a staple of shortterm stabilization policy but a
determinant of long-run growth as well.
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Savings Incentives
• Supply-side economists favor tax
incentives encouraging saving as well
as greater tax incentives for investment.
– Saving is that part of disposable income
not spent on current consumption.
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Government Finance
• When government borrows to finance
its spending, it dips into the nation’s
saving pool.
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Government Finance
• Crowding out is a reduction in privatesector borrowing (and spending) caused
by increased government borrowing.
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Government Finance
• Crowding in is a increase in privatesector borrowing (and spending) caused
by decreased government borrowing.
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Government Finance
• Fiscal and monetary policies must be
evaluated in terms of impact on long-run
aggregate supply as well as short-run
aggregate demand.
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Deregulation
• Government regulations impacts
aggregate supply by:
– Limiting the flexibility of producers to
respond to changes in demand.
– Raising production costs.
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Deregulation
• Factor Markets
– Minimum wage laws.
– OSHA standards.
– More people would be hired without
regulation.
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Deregulation
• Product Markets
– Transportation costs
– Food and drug standards
– Regulation causes restricted supply
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Deregulation
• The basic contention of supply-side
economists is that regulatory costs are
too high.
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Economic Freedom
• Nations with the most economic
freedom have the highest GDP per
capita and grow the fastest.
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2001 Levels of Economic
Freedom
2000 Per Capita Income in Purchasing Power Parties
$26,855
25,000
20,000
$12,569
15,000
10,000
$3,229
5,000
Free
Hong Kong
New Zealand
Luxembourg
United States
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Mostly free
Canada
Japan
Peru
Mexico
Mostly unfree
Indonesia
Brazil
Egypt
Russia
$3,585
Repressed
Libya
Belarus
Cuba
North Korea
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Is More Growth Desirable?
• More growth can lead to:
– Congestion
– Air pollution
– Depleted natural resources
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Is More Growth Desirable?
• The debate usually centers around the
mix of goods and services being
provided rather than the quantity of
output.
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Economic Growth
End of Chapter 14
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