Download As we learned already, the key ingredient to long

As we learned already, the key ingredient to long‐run growth is productivity, and the three components of productivity are physical capital, human capital and technology. So how can economies plan for long‐run growth?
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One reason why countries’ growth rates differ greatly is because some increase their stock of physical capital much more quickly than others through higher rates of investment spending. For example, today, China is the fastest growing major economy, and no surprise, it spends a significant amount on physical capital goods. In 2009, investment spending was 44% of China’s GDP, compared to only 18% in the US. Investment spending is the key to an increase in physical capital. And remember the two ways of increasing investment spending is either through an increase in savings from domestic households or an inflow of foreign capital—savings from foreign households.
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Making education a priority is necessary to increase long‐run growth. We saw this earlier in our d ti
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case study comparison of Latin America and East Asia. While originally, East Asia’s economies were smaller than Latin Americas’, the increase effort of adding human capital or a strong public education, in East Asia led to a huge surge in productivity in a relatively short amount of time. What drives technology? Scientific advances make new techonologies possible, but science alone is not enough…scientific knowledge must be transferred into useful products and processes. This often requires a lot of research and development or R&D spending to create new technologies and
often requires a lot of research and development or R&D, spending to create new technologies and prepare them for practical use.
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Government has a large role in promoting or hindering economic growth. First, let’s look at how the government affects physical capital.
Gov, plays a direct role in building infrastructure. What is infrastructure; can you think of some examples? Pause…Well if you listed roads, power lines, ports, information networks, you are exactly right! Infrastructure is any part of an economy’s physical capital that provides the foundation of economic activity.
Poor infrastructure—for example, a power grid that often fails, cutting off electricity to homes and b i
businesses—is a major obsticale
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infrastructure, an economy must not only be able to afford it, but also have the political discipline to maintain it and provide for the future.
There is one crucial infrastructure that we rarely think about, and that is basic public health measures in the form of clean water supply and disease control. The instability of public health is a major obsticle in the economic growth of poor countries.
Governments also play an important indirect role in making high rates of private investment Governments
also play an important indirect role in making high rates of private investment
spending possible. A well‐functioning banking system is very important for economic growth because in most countries is it the best way savings are channeled into investment spending. I you trust your bank, you will place your savings in bank deposits, which the bank will lend to their business customers…if you don’t trust them, if instead you hold on to gold, foreign currency, or keep your life savings under your mattress, then it cannot be turned into productive investment spending. A well‐functioning financial system requires appropriate government regulation that assures depositors that their funds are protected
assures depositors that their funds are protected.
While the majority of physical capital is created mainly through investment spending by individuals and private companies, human capital, is the result of government spending on education. Governments pay for the great bulk of primary and secondary education. As a result, differences in the rates at which countries add to their human capital largely reflect government policy. We say this when we compared East Asia with Latin America.
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Now that we have a background on long‐run growth, we now need to ask if this will always be the case. Some skeptics express doubt about whether long‐run economic growth is sustainable—
whether it can continue in the face of a limited supply of natural resources and the impact of growth on the environment.
Different views about the impact of limited natural resource son long‐run economic growth center on three questions: (read above)
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It’s mainly up to geologists to answer the first question, particularly concerning are current most i l
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valuable energy source, oil. Some believe there is so much untapped oil in the world that oil production can continue to rise for several decades. Others, believe that oil production will soon plateau and begin to decline in the near future.
The answer to the second question will come from engineers. We definitely have already made use of alternatives to natural resources. For example, electricity generated by wind turbines is rapidly becoming big business in the US
becoming big business in the US.
The third question, whether economies can continue to grow in the face of resource scarcity, is mainly a question for economists. And it’s important to note that most economists are optimistic. They believe that modern economies can find ways to work around limits on the supply of natural resources. One reason for this optimism is the act that resource scarcity typically leads to higher resource prices. These higher prices, in turn, provide strong incentives to conserve the scarce resource and find alternatives
resource and find alternatives.
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While economists generally believe resource scarcity is handled fairly well, environmental issues pose a more difficult problem because dealing with them requires effective political action. Economic growth tends to increase the human impact on the environment. For example, China’s huge economic growth has also brought a huge increase in air population throughout the country. Now this doesn’t necessarly mean that economic growth is killing our environment; many countires can and do take action to protect their environment through pollution regulations. However, most of these environmental success stories deal with local impacts of economic growth not global environmental issues The biggest of
with local impacts of economic growth, not global environmental issues. The biggest of these issues involves the change in the world’s climate. Now I’ll skip the science lesson because I’m sure you’ve all heard it before, but a rising global temperature may impose high human and economic costs: rising sea levels may flood coastal areas; changing climate may disrupt agriculture, especially in poor countries, and so on.
So the next question needs to be, is it possible to continue long‐run economic growth while curbing the emissions of greenhouse gases? What do you think? Pause…the answer is yes! Using energy sources like wind, solar and nuclear power are just some examples. The problem is how to make all of this happen. Unlike resource scarcity, environmental problems don’t automatically provide incentives for changed behavior. Pollution is an example of a negative externality, which is a cost that individuals or firms impose on others without having to offer compensation. Without government intervention, there honestly is no incentive to reduce negative externalities, which is why it took regulation to reduce air pollution in America’ss cities.
pollution in America
cities.
There is generally broad consensus among economists that the only way to deal with climate change is to get the government involved. Most also believe this should be done through market‐based incentives, such as a carbon tax—a tax per unit of carbon emitted. However, there is a great deal of dispute over how much action is appropriate, and obviously this is a argument that consistently gets a lot of news coverage today. The point is th t it i
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Long‐Run growth is fundamental to solving many of today’s pressing economic problems.
But the policies we studies previously throughout the semester address short‐run fluctuations. For example, an increase in household consumption can help an economy recover from a recession, but can that lead to long run growth? Typically, no, because when households increase consumption, they decrease their savings, which leads to decreased investment spending and slows long‐run economic growth. It is important to learn the difference between short‐run growth, fueled by fluctuations in the business cycle, and long‐run
long
run growth, which aims at steadily increasing our potential output over time. Now we growth which aims at steadily increasing our potential output over time Now we
are going to see how the macroeconomic models we learned this semester can reflect long‐run growth.
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Go ahead and draw a PPC like the one right here. Label your y‐axis with capital goods and your x‐
axis with consumer goods. Recall that the Production Possibilities Curve represents the trade‐offs facing an economy. Plot some points on the curve. Any point along the curve is a combination of capital and consumer goods that can be produced with full and efficient use of all resources. However, the PPC model does not tell use which of the possible points that economy should select. We know that if we have a point on the curve and the y‐axis, Point A, then the economy is solely producing physical capital and no consumer goods, a situation which the economy cannot survive.
If
If we have a point on the curve and the x‐axis, Point D, then we are only producing consumer goods h
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and no capital goods. Over time, as an economy produces more goods and services, some of its capital is used up in that production. A loss in value of physical capital due to wear, age or being obsolete leads to depreciation. This would lead to a decrease in production possibilities and an inward shift of the PPC.
So options of point A and D are out. That leaves point B and C. Which one is better for long run growth?
In order to shift our PPC outward over time, we must produce in a higher amount of capital goods than consumer goods…so point B is the most preferable place for an economy to be if it wants to focus on long‐run growth and forgo some temporary disappointment by consumers.
The government can promote long‐run growth by directly investing in physical capital such as infrastructure, or also by encouraging high rates of private investment spending by promoting a well‐functioning
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functioning banking system, property rights and political stability.
banking system property rights and political stability
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The AD‐AS Model is another useful tool for understanding long‐run growth. Recall that the Long Run Aggregate Supply curve shows the quantity of aggregate output supplied when all prices, including nominal wages, are flexible. It is vertical at potential output, Yp, because in the long run a change in the aggregate price level has no effect on the quantity of aggregate supplied.
It’s important to note that just as our production possibilities increase over time, as represented by the PPC our potential output also increases over time as represented by
represented by the PPC, our potential output also increases over time, as represented by the LRAS. This corresponds to a rightward shift of the LRAS curve. 8
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