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Economic Growth
CHAPTER SEVENTEEN
ECONOMIC GROWTH
CHAPTER OVERVIEW
In Chapter 12 we looked at the impact of economic growth in general and concentrated on the causes of
short-run fluctuations in employment and price levels and on policies that might mitigate such
instability. The issue of long-run economic growth is equally important. Although punctuated by
periods of cyclical instability, economic growth in the United States has been impressive. For example,
during the last half century, real output per person increased almost five-fold.
The discussion of growth in this chapter explores economic growth in more depth than in Chapter12. We
question whether the United States is achieving a “new economy” which might deliver a stronger future
rate of growth. Finally, we explore both positive and negative aspects of growth, and examine the issue
of growth in low-income nations.
INSTRUCTIONAL OBJECTIVES
After completing this chapter, students should be able to:
1. Identify six main ingredients in economic growth.
2. Show economic growth using production possibilities analysis and aggregate demand-aggregate
supply analysis.
3. Describe the growth record of the U.S. economy since 1950, including two measures of its
long-term growth rates.
4. Identify six major factors that contributed to U.S. economic growth according to empirical studies.
5. List three primary reasons for productivity acceleration in the United States since 1995.
6. List five reasons for increasing returns during the period of productivity acceleration.
7. Identify the macroeconomic implications of stronger productivity growth and more intense global
competition.
8. Evaluate the potential for the productivity acceleration to be a permanent phenomenon.
9. Identify and explain the arguments for and against economic growth.
10. Describe how low income nations can increase economic growth, both internally and with foreign
support.
11. Define and identify terms and concepts at the end of the chapter.
LECTURE NOTES
I.
Introduction
A. Two definitions of economics growth were given in Chapter 12.
1. The increase in real GDP, which occurs over a period of time.
2. The increase in real GDP per capita, which occurs over time. This definition is superior
if comparison of living standards is desired.
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B. Growth has been impressive in capitalist countries during the past half century. Real GDP in
the U.S. was 9 times greater in 2004 than in 1950. Real GDP per capita was almost 5 times
greater.
C. This chapter explores economic growth in more depth than Chapter 12.
II.
Six Main Ingredients of Growth
A. Four supply factors relate to the ability to grow.
1. The quantity and quality of natural resources,
2. The quantity and quality of human resources,
3. The supply or stock of capital goods, and
4. Technology.
B. Demand and efficiency factors are also related to growth.
1. Aggregate demand must increase for production to expand.
2. Full employment of resources and both productive and allocative efficiency are
necessary to get the maximum amount of production possible.
III.
Production Possibilities Analysis (Figure 17.1)
A. Growth can be illustrated with a production possibilities curve (Figure 17.1), where growth
is indicated as an outward shift of the curve from AB to CD.
1. Aggregate demand must increase to sustain full employment at each new level of
production possible.
2. Additional resources that shift the curve outward must be employed efficiently to make
the maximum possible contribution to domestic output.
3. For the economy to achieve the maximum increase in value, the optimal combination of
goods must be achieved (allocative efficiency).
B. The long-run aggregate supply curve can also be used to illustrate growth, as seen in Figure
17.2. Changes in supply factors cause the shift in long-run aggregate supply.
C. Focus on the supply side is further illustrated in Figure 17.3, where growth depends on labor
inputs multiplied by labor productivity.
1. Increased labor inputs depend on size of population and labor force participation rate
(the percent of population actually in the labor force).
2. Productivity is determined by technological progress, the availability of capital goods,
quality of labor itself, and efficiency with which inputs are allocated, combined, and
managed.
D. Applying the Analysis: U.S. Economic Growth Rates
1. Real GDP grew by 3.5 percent per year from 1950 to 2004.
2. Real GDP per capita grew by 2.3 percent per year from 1950 to 2004.
3. Although growth surged from 1996 to 2000, average rates of growth from 1970 to
present have been lower than from 1950 to 1970.
IV.
Accounting for growth
A. Accounting for growth is an attempt to quantify factors contributing to economic growth.
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B. More labor input is one source of growth. Labor force has grown about 1.7 million workers
per year for past 51 years and has accounted for anywhere from about one-quarter to one-half
of total economic growth. (See Table 17.1)
C. Labor productivity growth contributed about 75 percent of the economic growth from 1995
to 2004, and it is expected to contribute around 70 percent from 2004 to 2010.
D. Technological advance, the most important factor, has been estimated to contribute about 40
percent of the U.S. productivity growth.
E. Increases in quantity of capital are estimated to have contributed about 30 percent to
productivity growth in the United States.
F. Education and training improve the quality of labor (human capital), and has contributed
about 15 percent of U.S. productivity growth. (See Figure 17.5)
G. Improved resource allocation and economies of scale also contribute to growth and explain
about 15% of total growth in productivity.
1. Improved resource allocation has occurred as discrimination disappears and labor moves
where it is most productive, and as tariffs and other trade barriers are lowered.
2. Economies of scale occur as the size of markets and firms that serve them have grown.
H. Other factors influence growth and are more difficult to measure.
1. The social cultural environment and political stability are “growth friendly” in U.S.
a. Respect for material success provides incentive to increase incomes.
b. Market system rewards actions that increase output.
c. Property rights and legal system encourage growth.
2. Positive attitudes toward work and flow of energetic immigrants also add to growth.
V.
The Productivity Acceleration: A New Economy? (Figure 17.6)
A. Improvement in standard of living is linked to labor productivity – output per worker per
hour.
B. The U.S. is experiencing a resurgence of productivity growth based on innovations in
computers and communications, coupled with global capitalism. Since 1995 productivity
growth has averaged 2.9% annually – up from 1.4% over 1973-95 period. The “Rule of 70”
projects real income will double in 24 years rather than 50 years.
C. Much of the recent improvement in productivity is due to “new economy” factors such as:
1. Microchips and information technology are the basis for improved productivity. Many
new inventions are based on microchip technology.
2. New firms and increasing returns characterize the new economy.
a. Some of today’s most successful firms didn’t exist 30 years ago: Dell, Compaq,
Microsoft, Oracle, Cisco Systems, America Online, Yahoo and Amazon.com are just
a few of many.
b. Economies of sale and increasing returns in new firms encourage rapid growth.
3. Sources of increasing returns include:
a. More specialized inputs.
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b. Ability to spread development costs over large output quantities since marginal costs
are low.
c. Simultaneous consumption by many customers at the same time.
d. Network effects make widespread use of information goods more valuable as more
use the products.
e. Learning increases with experience.
4. Global competition encourages innovation and efficiency.
D. Implication: More Rapid Economic Growth
1. Greater shifts in production possibilities (Figure 17.2)
2. Faster growth without inflation is possible with higher productivity.
3. Global competition keeps prices stable by limiting market power.
E. A “new economy” does not mean the business cycle is dead, as evidenced by the 2001
recession. However, productivity growth remained strong during the recession.
F. Skepticism about long-term continued growth remains, and only time will tell.
VI.
Is Growth Desirable and Sustainable?
A. Global Snapshot 17.1: Global Competitiveness Index
Economic growth potential depends on factors such as innovativeness, effectiveness at
transferring technology between sectors, efficiency of the financial system, rates of
investment, and integration with the rest of the world. The World Economic Forum ranks
nations according to these criteria.
B. An antigrowth view exists.
1. Growth causes pollution, global warming, ozone depletion, and other problems.
2. Growth does not solve problems such as poverty, homelessness, and discrimination.
3. “More” is not always better if it means dead-end jobs, burnout, and alienation from one’s
job. A “better living” does not imply a “good life.”
4. High growth creates high stress, especially as technological changes threaten to erode
marketable skills.
C. Others argue in defense of growth.
1. Growth leads to an improved standard of living.
2. Growth helps to provide infrastructure, as well as services for the disadvantaged in
society.
3. Growth has improved working conditions.
4. Growth allows more leisure and less alienation from work.
5. Environmental concerns are important, but growth actually has allowed more sensitivity
to environmental concerns and the ability to deal with them.
D. Is growth sustainable? Yes, say proponents of growth.
1. Resource prices are not rising; when prices do rise, others are substituted.
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2. Growth today has more to do with expansion and application of knowledge and
information, so is limited only by human imagination.
E. Applying the Analysis: Growth in the Low-Income Nations
1. Approximately 2.8 billion people live on $2 or less per day, compared to a U.S. per
capita GDP in 2004 of almost $37,000. Economic growth is literally a matter of life and
death.
2. Many of these low-income nations are in Africa; some are in Asia, East Asia, and Latin
America.
3. Low-income nations have low levels of industrialization, low literacy rates, high
unemployment, and rapid population growth. The limited capital and technology
combine for low levels of labor productivity.
4. Economists have suggested a number of options for promoting growth in low-income
nations:
a. Establish and implement the rule of law, enforce property rights, reduce corruption,
and create an environment where prospective firms can keep the fruits of their labor.
b. Control population growth.
c. Develop human capital through improved education.
d. Expand international trade and openness to foreign investment.
e. Establish central banks that maintain price stability.
f.
Convert government operated firms into private enterprises.
g. Make peace with neighbors so that resources flowing into the military can be
reallocated toward private capital and public infrastructure.
5. Advanced industrial nations can also promote growth in low-income countries, although
these suggestions are more controversial.
a. Direct aid to the poorest nations, not simply to those that provide the most military or
political support.
b. Reduce trade barriers on goods imported from low-income nations, including
domestic subsidies on agricultural products in advanced nations. This would allow
low-income nations to expand their export earnings and finance development.
c. Forgive the debts of low-income nations, which some nations have already agreed to
do. The concern is that debt forgiveness may encourage future borrowers to be
reckless in their spending. Concern that low-income nations may expect future debt
forgiveness may also discourage future lenders.
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