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Economic Growth The Production Function Production Possibilities Growth Policies U.S. Economic Growth 2: Actual and Potential GDP in the United States FIGURE 11,000 10,500 10,000 9,500 9,000 Actual GDP 8,500 8,000 7,500 Billions of 2000 Dollars 7,000 6,500 Potential GDP 6,000 5,500 5,000 1982 –1983 Recession 4,500 1974 –1975 Recession 4,000 3,500 1960s Boom 3,000 2,500 1957 –1958 Recession 2,000 1955 1959 1960 –1961 Recession 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2004 Year Copyright © 2003 South-Western/Thomson Learning. All rights reserved. Questions What causes long-term GDP (potential GDP) and per-capita GDP (standard of living) to grow over time? What types of economic policies can the government use to stimulate GDP growth? Growth and Production Function The key to growth in potential GDP is growth in labor/worker productivity: Yp = L* x (Y/L*) = (Hours of work) x (Labor productivity) What drives labor productivity growth? Three Pillars of Productivity Growth: (i) Capital (K) (ii) Technology (TFP) (iii) Human capital (HK) - One measure is educational attainment. Productivity Growth and shifts in the production function. Growth Accounting in US 1948-73 Labor Productivity 2.8% Capital 0.9% Technology 1.9% 73-95 94-02 1.4% 2.8% 1.0% 1.7% 0.4% 1.1% 4: Average Years of Schooling for Selected Countries TABLE Growth and Production Possibilities Goods can be classified into two types: (i) Consumption goods – to be consumed (not used to make goods). (ii) Capital goods – to be used in the manufacturing of other goods (may include human capital) GDP must be divided between consumption and capital goods. Capital Goods GDP and Society’s Choices Today c b PPF0 a Consumption Goods Capital Goods GDP and Society’s Choices: Tomorrow (if No Capital Depreciation): Choice a c b PPF0 = PPFa a Consumption Goods Capital Goods GDP and Society’s Choices Tomorrow: Choice b c b PPFb PPFa a Consumption Goods Capital Goods GDP and Society’s Choices Tomorrow: Choice c c PPFc PPFb b PPFa a Consumption Goods For a given level of technology investment in physical or human capital is necessary for economic growth. Increases in TFP can increase economic growth for any given capital-consumption combination. Capital Goods GDP and Society’s Choices: Growth in TFP PPF1 c b PPF0 a Consumption Goods International Comparisons What explains international differences in standard of living? How have these differences changed over time? Poorer countries low per-capita GDP Richer countries high per-capita GDP Productivity and Growth in Selected Countries Country US France UK Germany GDP/Hour 1998 (% of US) 100 98 79 77 Growth 1.5 2.5 2.2 2.4 The convergence hypothesis: Productivity growth of poorer countries tend to be higher than richer countries. Per-capita GDP among countries tend to converge. Productivity in Selected Countries Country US France UK Germany GDP/Hour 1973 (% of US) 100 76 67 62 GDP/Hour 1998 (% of US) 100 98 79 77 Growth 1.5 2.5 2.2 2.4 Figure 2 The Convergence Hypothesis Reasons for International Convergence (i) Diminishing Returns (ii) Learning from Richer Countries Problem: Poorest countries are falling behind. They don’t have (i) Infrastructure, facilities (ii) Educational structure Productivity in Selected Countries Country US France UK Germany Argentina Mexico Peru GDP/Hour 1973 (% of US) 100 76 67 62 45 38 26 GDP/Hour 1998 (% of US) 100 98 79 77 39 29 15 Growth 1.5 2.5 2.2 2.4 0.9 0.5 -0.7 Growth Policies Capital Formation Policies: * Lower Interest Rates * Tax Provisions (capital gains/corporate) * Political Stability/Property Rights * Direct Government Investment Education and Training Helping Developing Countries (foreign direct investment, World Bank Aid) 5: Average Productivity Growth Rates in the U.S. FIGURE 3.0 Percent per Year 2.8 1.4 1948–1973 1973–1995 1995–2004 Copyright © 2006 South-Western/Thomson Learning. All rights reserved. Historical Record of U.S. Productivity Post WWII: 1948-73 * Confidence and business optimism high * Low Interest Rates * High government spending on infrastructure Productivity Slowdown: 1973-1995 * High energy prices * Slow pace of technical progress? 1995-present * Lower energy prices * Peace Dividend * Computing and Information Technology