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17:Long-Term
Economic Growth
 What are the long-term growth trends
in the United States and other
countries?
 What are the main factors that
influence long-term growth?
 What policies might be used to
speed up economic growth?
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Economic Miracles
 U.S. real GDP per person almost
doubled between 1960 and 1995.
 However, this growth has been
uneven with periods of recession
and expansion.
 Incomes in Asian economics have
grown eightfold between 1960 and
1995.
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Long-Term Growth Trends
 Long-term growth is the trend growth
rate of potential GDP.
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 Potential GDP grows for two
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reasons:
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 Population growth
 Growth in potential GDP per person
 Only the second brings rising living
standards.
Growth in the U.S. Economy
 U.S. economic growth averaged 1.7
percent per year between 1895 and
1995.
 During the 1960s growth was 2.5
percent per year.
 Since 1973 growth has slowed to 1.4
percent per year due to the slowing
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of productivity growth.
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A Hundred Years of Economic
Growth in the United States
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Two Extraordinary Events
 The Great Depression of the 1930s
saw a fall in real GDP unlike anything
else in the past 100 years.
 The boom created by World War II
was a major expansion of real GDP.
 However, between 1929 and 1953,
growth averaged 1.8 percent a year.
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Real GDP Growth in
the World Economy
 Among the richest countries, the
United States and Canada have had
the highest real GDP per person
since 1960.
 However, Japan has been growing
the fastest - until recently.
 Africa and Central and South
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America grew at a slower rate.
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Figure 10.2 page 215
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Figure 10.2 page 215
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Catch-Up in Asia
 Hong Kong, Korea, Singapore, and
Taiwan are catching up with the
United States.
 China has a high growth rate, but
started very far behind the United
States and still has a long way to go.
 Continued growth of China’s
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economy is important for
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world gdp for 21st century
Note the rate of growth here has slowed in 97.98
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The Sources of
Economic Growth
 Societies that do not experience
economic growth lack some
fundamental social institutions and
arrangements that are essential
preconditions for economic growth:
 Markets
 Property rights
 Monetary exchange
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Markets
 Markets enable buyers and sellers to
get information and to do business
with each other.
 Market prices send signals to buyers
and sellers that create incentives to
increase or decrease the quantities
demanded and supplied.
 Markets encourage specialization
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and trade.
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Property Rights
 Property rights are the social
arrangements that govern the
ownership, use, and disposal of
factors of production such as:
 physical property (land, buildings)
 financial property (claims by one person
against another)
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 intellectual property (inventions)
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Monetary Exchange
 Monetary exchange facilitates
transactions of all kinds, including
the orderly transfer of private
property from one person to another.
 Property rights and monetary
exchange create incentives for
people to specialize and trade, to
save and invest, and to invent new
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technologies.
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Specialization and Growth
 Specialization leads to growth,
improving the standard of living.
 For growth to continue, people must
have incentives to pursue three
activities:
 Saving and investment in new capital
 Investment in human capital
 Discovery of new technologies
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Saving and Investment
in New Capital
 Saving and investment in new capital
increase the amount of capital per
worker and increase human
productivity.
 Production methods that use large
amounts of capital per worker (such
as assembly lines) are much more
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productive than using hand tools.
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Investment in
Human Capital
 Human capital is the accumulated
skill and knowledge of human
beings.
 Investment in human capital is a
source of both increased
productivity and technological
advance.
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Discovery of New
Technologies
 Technological change makes an
enormous contribution to our
increased productivity.
 It arises from research and
development as well as trial and
error.
 Most technologies must be
embodied in physical capital.
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Growth Accounting
 Labor Productivity
 Labor productivity is real GDP per hour
of work.
• Equals real GDP divided by aggregate labor hours
 Determines how much income an hour
of labor generates
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Growth Accounting
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Growth Accounting
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 Growth accounting divides growth
into two components.
1) Growth in capital per hour of labor
2) Technological change
• Includes everything that contributes to labor
productivity growth that is not included in growth in
capital per hour
Growth Accounting
 The Productivity Function
 A relationship that shows how real GDP
per hour of labor changes as the
amount of capital per hour of labor
changes with a given state of
technology.
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Growth Accounting
 The Productivity Function
 The shape of the productivity function
reflects the law of diminishing returns.
 The law of diminishing returns states
that as the quantity of one input
increases with the quantities of all other
inputs remaining the same, output
increases but by ever smaller
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increments.
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Real GDP per hour of work (1992 dollars)
How Productivity Grows
32
25
20
0
30
60
Capital per hour of work (1992 dollars)
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Real GDP per hour of work (1992 dollars)
How Productivity Grows
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PF0
25
20
GDP/HW=A*F(CAP/HW)
0
30
60
Capital per hour of work (1992 dollars)
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Real GDP per hour of work (1992 dollars)
How Productivity Grows
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PF0
25
20
0
30
60
Capital per hour of work (1992 dollars)
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Real GDP per hour of work (1992 dollars)
How Productivity Grows
PF0
32
PF0
25
Effect of
technological
change
20
Effect of
increase
in capital
stock
0
30
60
Capital per hour of work (1992 dollars)
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Growth Accounting
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 The Productivity Function
 Applying the law of diminishing returns
to capital, the law states that if a given
number of hours of labor use more
capital, the additional output that
results from the additional capital gets
smaller as the amount of capital
increases.
 The one third rule explains how much
less.
Growth Accounting
 The One Third Rule
 Robert Solow of MIT discovered that on
average, with no change in technology,
a 1 percent increase in capital per hour
of labor brings a one third of a 1 percent
increase in real GDP per hour of labor.
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Growth Accounting
 Accounting for the Productivity
Growth Slowdown and Speedup
 We can use the one third rule to study
U.S. productivity growth and the
productivity growth slowdown.
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Growth Accounting
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 Accounting for the Productivity
Growth Slowdown and Speedup
 1960 to 1973
• The economy grew due to rapid technological
changes.
• Real GDP per hour expanded by 39%
• Capital per hour increased by 24%
• With no change in technology, the economy would
have expanded by only 8% (1/3 of 24%)
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Growth Accounting
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 Accounting for the Productivity
Growth Slowdown and Speedup
 1973 to 1983
• Predominantly, the reason for the productivity
growth slowdown can be attributed to a decline in
the rate of technological change.
• Real GDP per hour expanded by 8%
• Capital per hour increased by 15%
• With no change in technology, the economy would
have expanded by 5% (1/3 of 15%)
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Growth Accounting
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 Accounting for the Productivity
Growth Slowdown and Speedup
 1983 to 1995
• The economy grew due to more rapid technological
change.
• Real GDP per hour expanded by 18.5%
• Capital per hour increased by 11%
• With no change in technology, the economy would
have expanded by only 3.7% (1/3 of 11%)
Growth Accounting and the
Productivity Growth Slowdown
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Growth Accounting
 Technological Change During the
Productivity Growth Slowdown
 Technology was directed toward coping
with two major problems.
1) Energy price shocks
2) The environment
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Growth Accounting
 Technological Change During the
Productivity Growth Slowdown
 Energy Price Shocks
• 1973–1974 and 1979—1980
• Fuel inefficient methods of transportation and
production were scrapped at an increased rate
• Technological change focused on saving energy
rather than enhancing productivity
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Growth Accounting
 Technological Change During the
Productivity Growth Slowdown
 The Environment
• The 1970s saw an expansion of laws and resources
devoted to protecting the environment and
improving the quality of the workplace.
• These benefits are not included in real GDP.
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