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Economic Growth McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. The Nature of Growth • Economic growth refers to increases in the output (real GDP) – an expansion of production possibilities. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Two Types of Growth • The short run — increased capacity utilization • The long run — expanded capacity McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Short-Run Changes in Capacity Use • The easiest kind of growth comes from the increased use of our productive capacity. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Short-Run Changes in Capacity Use • We do not always take full advantage of our productive capacity. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 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. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. INVESTMENT GOODS (quantity per year) Short-Run Growth: Increased Capacity Utilization 0 McGraw-Hill/Irwin B A CONSUMPTION GOODS (quantity per year) © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Long-Run Changes in Capacity • To achieve large and lasting increases in output, the production possibilities must be pushed outward. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Long-Run Changes in Capacity • Economists tend to define economic growth in terms of changes in potential GDP. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. INVESTMENT GOODS (quantity per year) Long-Run Growth: Expanded Capacity 0 McGraw-Hill/Irwin C B A CONSUMPTION GOODS (quantity per year) © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Aggregate Supply Focus • Economic growth is possible only if the AS curve shifts right. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Supply-Side Focus DETERMINANTS OUTCOMES Jobs Internal market forces AS Prices External shocks Growth Policy levers: fiscal policy monetary policy supply-side policy Output McGraw-Hill/Irwin AD International balances © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Nominal vs. Real GDP • Economic growth refers to increases in real GDP. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Nominal vs. Real GDP • Nominal GDP is the total value of goods and services produced within a nation’s borders, measured in current prices. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Nominal vs. Real GDP • Real GDP is the inflation-adjusted value of GDP; the value of output measured in constant prices. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. The GDP Growth Rate • Growth rate is the percentage change in real GDP from one period to another. Growth Rate McGraw-Hill/Irwin = change in real GDP base period GDP © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. The GDP Growth Rate • Challenge for the future is to maintain higher rates of economic growth. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 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 McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 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. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. GDP per Capita: A Measure of Living Standards • GDP per capita — total GDP divided by total population. • It is average GDP. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. GDP per Capita: A Measure of Living Standards • Growth in GDP per capita is attained only when growth of output exceeds population growth. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. GDP per Capita: A Measure of Living Standards • U.S. GDP per capita has more than doubled since Ronald Reagan was president. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. The History of World Growth $6,000 5,000 4,000 3,000 2,000 1,000 0 1000 McGraw-Hill/Irwin 1500 1820 1995 © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 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. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 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 McGraw-Hill/Irwin Doubling Time (years) Never 144 72 48 36 29 24 21 18 16 14 © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. GDP per Worker • GDP per worker is a measure of productivity • Average workers today produce nearly twice as much as their parents. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 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. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. GDP per Worker • The U.S. employment rate also increased. – The employment rate is the proportion of the population that is employed. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 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. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Productivity Gains Average annual productivity increase 1990-99 1.8 McGraw-Hill/Irwin 2.0 2.5 2.6 2.7 4.1 4.2 5.3 © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Sources of Productivity Growth • Sources of productivity gains include: – Higher skills – More capital – Improved management – Technological advance McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Labor Quality • As education and training levels rise, so does productivity. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 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. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Average Annual Growth Rate of Labor, Capital, and Productivity Period 1959-65 1965-69 1969-73 1973-79 1979-85 McGraw-Hill/Irwin 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 © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Management • Entrepreneurship and the quality of continuing management are major determinants of economic growth. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Management • There is a potential conflict between short-term profits and long-term productivity gains. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Management • Managers must develop personnel structures and incentives that make employees want to contribute to production. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Research and Development • • • • Scientific research Product development Innovations in production technique Development of management improvements McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Policy Levers • Government policies can have a major impact on whether, and how far, the aggregate supply curve shifts. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 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. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 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. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Investment Incentives • Tax policy is not only a staple of shortterm stabilization policy but a determinant of long-run growth as well. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 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. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Government Finance • When government borrows to finance its spending, it dips into the nation’s saving pool. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Government Finance • Crowding out is a reduction in privatesector borrowing (and spending) caused by increased government borrowing. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Government Finance • Crowding in is a increase in privatesector borrowing (and spending) caused by decreased government borrowing. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 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. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Deregulation • Government regulations impacts aggregate supply by: – Limiting the flexibility of producers to respond to changes in demand. – Raising production costs. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Deregulation • Factor Markets – Minimum wage laws. – OSHA standards. – More people would be hired without regulation. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Deregulation • Product Markets – Transportation costs – Food and drug standards – Regulation causes restricted supply McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Deregulation • The basic contention of supply-side economists is that regulatory costs are too high. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Economic Freedom • Nations with the most economic freedom have the highest GDP per capita and grow the fastest. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. 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 McGraw-Hill/Irwin Mostly free Canada Japan Peru Mexico Mostly unfree Indonesia Brazil Egypt Russia $3,585 Repressed Libya Belarus Cuba North Korea © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Is More Growth Desirable? • More growth can lead to: – Congestion – Air pollution – Depleted natural resources McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Is More Growth Desirable? • The debate usually centers around the mix of goods and services being provided rather than the quantity of output. McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Economic Growth End of Chapter 14 McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.