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CHAPTER 15 Economic Growth LEARNING OBJECTIVES After reading this chapter, you should be able to: 1 2 3 4 5 Specify how economic growth is measured. Describe what GDP per capita and GDP per worker measure. Illustrate how productivity increases. Explain how government policy affects growth. Discuss why economic growth is desirable. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-1 CHAPTER 15 The goal of this chapter is to explorer a long term view of economic performance. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-2 THE NATURE OF GROWTH Economic growth refers to increases in the output of goods and services. • Measured as an increase in real GDP. • Short run higher output can come from efficiently using resources. • Long lasting higher output requires an expansion of productive capacity. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-3 THE NATURE OF GROWTH There are two ways to expand output. The long run: Expanded capacity B A 0 INVESTMENT GOODS (quantity per year) INVESTMENT GOODS (quantity per year) The short run: Increased capacity utilization C B A 0 CONSUMPTION GOODS (quantity per year) CONSUMPTION GOODS (quantity per year) 15-4 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. THE NATURE OF GROWTH Economists define economic growth in terms of changes in potential GDP. • Measured as sustained increases in total output. • Reductions in inefficiencies increase output until producing at capacity. • Increase in AS leads to an expansion of production capacity. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-5 THE NATURE OF GROWTH To achieve long-run growth, AS must shift outward. DETERMINANTS Internal market forces OUTCOMES AS Output Jobs External shocks Prices Growth Policy levers: Fiscal policy Monetary policy Supply Side Policy AD Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. International Balance 15-6 GROWTH INDEXES Measures of economic growth must net out changes in prices over time. • Nominal GDP measures value of output in current prices. • Changes in value occur from changes in prices and output. • Real GDP measures value of output in constant prices, inflation-adjusted. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-7 GROWTH INDEXES Changes in real GDP measures economics growth. • The growth rate is the percentage change in real GDP between time periods. Growth rate = Change in real GDP Base period GDP Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-8 GROWTH INDEXES GROWTH RATE (percent per year) U.S. growth has generally been positive, with real GDP growing on average 3% per year. 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0 -1.0 -2.0 -3.0 -4.0 1970 1975 1980 1985 1990 1995 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without YEAR the prior written consent of McGraw-Hill Education. 2000 2005 2010 2015 15-9 GROWTH INDEXES The Rule of 72 provide the approximate number of years to double. Growth Rate (Percent) Doubling Time (Years) 0.0 Never 0.5 144 1.0 72 1.5 48 2.0 36 2.5 29 3.0 24 3.5 21 4.0 18 4.5 16 5.0 14 The time to double is 72 divided by the growth rate. Growing at 2% takes 72/2 = 36 yrs. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-10 GROWTH INDEXES Small changes in growth rates magnify into large differences in output over time. • Low growth implies lost output. • Growth gains from one year accumulate into higher output in future years. • Growth is an exponential process. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-11 GROWTH INDEXES Growth in GDP per capita is only attained when the growth of output exceeds population growth. • • • GDP per capita is total output divided by total population. U.S. GDP per capita has more than doubled since 1980. Many non-western countries have high population growth, slowing economic growth and prosperity. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-12 GROWTH INDEXES Economies do not grow at the same rate. GDP per Capita in 1990 International Dollars Year 0 1000 1500 1820 1995 World $425 $420 $545 $675 $5,188 The West $439 $406 $624 $1,149 $19,990 West Europe $450 $400 $670 $1,269 $17,456 North America $400 $400 $400 $1,233 $22,933 Japan $400 $425 $525 $675 $19,720 The Rest $423 $424 $532 $594 $2,971 Other Europe $400 $400 $597 $803 $5,147 Latin America $400 $415 $415 $671 $5,031 China $450 $450 $600 $600 $2,653 Other Asia $425 $425 $525 $560 $2,768 Africa $400 $400 $400 $400 $1,221 Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-13 GROWTH INDEXES Growth in GDP per capita typically raises living standards. • • • • More goods and services produced. Better goods and services produced. Increased wealth. The distribution of gains may not be equal across individuals. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-14 GROWTH INDEXES Average U.S. workers today produce twice as much as their parents did. Producing more output requires either: 1. Working more hours. 2. Working more productively. • Productivity is defined as output per unit of input. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-15 GROWTH INDEXES Historically, productivity gains have been a major source of economic growth. +70% +50% +20% Labor hours Output Total per hour output • U.S. labor force and employment grew faster than population. • Productivity grew even faster than labor input. • Caused U.S. GDP and GDP per capita to rise. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-16 SOURCES OF PRODUCTIVITY GROWTH There are four sources of productivity gain. 1. 2. 3. 4. Labor skills. Capital intensity. Resource management. Technology advances. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-17 SOURCES OF PRODUCTIVITY GROWTH 1. Increases in education and training improve the quality of the labor force. • Education and training endow workers with more skills. • Workers with more skills leads to productivity increases. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-18 SOURCES OF PRODUCTIVITY GROWTH 2. Capital increases each worker’s productivity. • Investment in more and better tools and equipment sets up the average worker to be more productive. • Capital is a prime determinant of productivity and growth. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-19 SOURCES OF PRODUCTIVITY GROWTH 3. Entrepreneurship and the quality of management are major determinants of economic growth. • Managers must develop personnel structures and incentives that make employees contribute to production. • Difficult to characterize differences in management techniques. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-20 SOURCES OF PRODUCTIVITY GROWTH 4. Research and development (R&D) leads to the upgrading of equipment, processes, products, and also workers. R&D includes: 1. 2. 3. 4. Scientific research. Product development. Innovations in production technique. Development of management improvements. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-21 POLICY LEVERS Government policies have a major impact on whether and how far the AS shifts. Policies on: 1. Education and training. 2. Immigration. 3. Savings and investment. 4. Deregulation. 5. Economic Freedoms. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-22 POLICY LEVERS 1. Government policies that support education and training have a several payoffs. • Stimulate economy in short run. AD curve shifts outward. • Increase production capacity in longrun. AS curve shifts outward. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-23 POLICY LEVERS 2. The quality and quantity of labor are affected by immigration policy. • Direct contributor to an outward shift of production possibilities. • Immigrants may improve labor allocation of all workers. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-24 POLICY LEVERS 3. Government stimulates investment through tax policies. • Lower taxes on capital gains may stimulate investment. • Tax policy is permits short-run stabilization and increases capacity. • Tax treatment of capital gains is one of the most debated policy levers. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-25 POLICY LEVERS Supply-side economists favor tax incentives that encourage saving and investment. • These policies stimulate production. • In sharp contrast to Keynes’ emphasis on stimulating consumption. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-26 POLICY LEVERS While tax policies promote investment, budget deficits may reduce private investment. • When government finances spending, it borrows from nation’s savings. • Potentially crowds out and decreases private-sector investment. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-27 POLICY LEVERS Government budget surpluses may crowd in private investment. • Crowding in occurs when reductions in government borrowing increase privatesector borrowing. • Requires evaluation of impact on shortrun AD and on long-run AS. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-28 POLICY LEVERS 4. Government regulation impacts AS. • Several types of regulation. • Limits flexibility of producers to respond to changes in demand. • May raise production costs. • Deregulation potentially stimulates economic growth. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-29 POLICY LEVERS Regulation of factor markets include: • Minimum-wage laws. • Occupational Safety and Health Administration (OSHA) standards. Unintended consequences of these regulations are fewer people are hired. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-30 POLICY LEVERS Regulation of markets raises production costs and restricts supply. • Supply-side economists suggest regulatory costs are too high and shifts AS curve inward. • Includes regulation of transportation, financial markets, and food and drug standards. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-31 POLICY LEVERS Any government regulation shifts decision-making power from the private sector to the public sector. • Excessive government regulation reduces economic freedom. • Nations with the most economic freedom have the highest GDP per capita and grow the fastest. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-32 POLICY PERSPECTIVE Is more growth desirable? Growth can lead to: • Congestion. • Air pollution. • Depleted natural resources. The growth debate centers around the mix of goods and services being provided. Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-33