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Economic Growth Chapter 10 Basics of Economic Growth • How to calculate growth rate – Growth rate of real GDP = (real GDP in current year – real GDP in previous yea) / real GDP in previous year * 100 – Growth rate of real GDP per capita = growth rate of real GDP – growth rate of population • Rule of 70 – The number of years it takes for the level of any variable to double is approximately 70 divided by the annual growth rate of the variable Sources of Economic Growth • Sources – – – – Increase in labor (aggregate hours) Physical capital growth Human capital growth Technology advance • The last three sources contribute to economic growth through labor productivity – Labor productivity = real GDP / aggregate hours Sources of Economic Growth Continued • Productivity curve – Relationship between labor productivity (real GDP per hour of labor) and the amount of physical per hour of labor – Movement along the productivity curve is caused by changes in capital per hour of labor. • One third rule: 1% capital increase 1/3 % labor productivity – Shift of the productivity curve is caused by changes in human capital and technological advance. – Why lower labor productivity growth in the 1970s? Theories of Economic Growth • Classical growth theory – A pessimistic view that an exploding population and limited resources will eventually bring economic growth to an end. – Also called Malthusian theory – Process • Initially economic growth from subsistence level with more capital and technology advance population growth and no more resources push the economy back to the subsistence level – Background: population explosion of 18th c. Europe Theories of Economic Growth Continued • Neoclassical growth theory – Population growth and technology advance will affect economic growth, but as long as technology keeps advancing, the economy will grow. – Technology advance is exogenous (a result of chance). – Background: no more population explosion in the 19th and 20th c. – Shortcoming: no explanation of how technology advances. Theories of Economic Growth Continued • New growth theory – Our unlimited wants will lead us to ever greater productivity and perpetual economic growth. – Our choices and preference for better living and profits lead us new discoveries and accumulation of human capital. – Competition squeeze profits seeking new discoveries – Continuous shift up of the productivity curve Preconditions for Economic Growth • Preconditions: Economic freedom – Freedom of individuals and businesses from government restraints on economic activities – Legal and institutional frameworks to safeguard economic freedom (such as property rights and contract laws) – Visit www.heritage.org for ranking of individual countries. Policies to Achieve Economic Growth • • • • • • Create the incentive mechanisms Promote competition Promote international trade Encourage saving Encourage investment, particularly R & D. Improve quality of education and training