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Economics: Principles and Applications, 2e by Robert E. Hall & Marc Lieberman © 2001 South-Western, a division of Thomson Learning Economic Growth and Rising Living Standards © 2001 South-Western, a division of Thomson Learning The Importance of Growth Achieving a higher rate of growth in the long run generally requires some sacrifice in the short run. © 2001 South-Western, a division of Thomson Learning The Importance of Growth When output grows faster than the population, GDP per capita--which we call the average standard of living--will rise. When output grows more slowly than the population, the average standard of living will fall. © 2001 South-Western, a division of Thomson Learning What Makes Economies Grow? Economic growth is a long-run phenomenon. The classical model is particularly well suited to analyze long-run economic problems, including the problem of growth. © 2001 South-Western, a division of Thomson Learning What Makes Economies Grow? The classical model states that the economy tends to operate at its full-employment output level over the long run. Economic growth depends upon changes that would cause full-employment output to increase. © 2001 South-Western, a division of Thomson Learning What Makes Economies Grow? Three Most Important Causes •Increases in Employment •Increases in the Capital Stock •Changes in Technology © 2001 South-Western, a division of Thomson Learning Growth in Employment •How to Increase Employment •Employment Growth and Productivity © 2001 South-Western, a division of Thomson Learning Growth in Employment Growth in employment can arise from an increase in labor supply (a rightward shift in the labor supply curve) or an increase in labor demand (a rightward shift of the labor demand curve). © 2001 South-Western, a division of Thomson Learning Growth in Employment A cut in tax rates increases the reward for working, while a cut in benefits to the needy increases the hardship of not working. Either policy can cause a greater rightward shift in the economy’s labor supply curve than would otherwise occur and speed the growth in employment and output. © 2001 South-Western, a division of Thomson Learning Growth in Employment Government policies that help increase the skills of the workforce or that subsidize employment more directly shift the economy’s labor demand curve to the right, increasing employment and output. © 2001 South-Western, a division of Thomson Learning Growth in Employment Labor Productivity Total output (real GDP) per worker. © 2001 South-Western, a division of Thomson Learning Growth in Employment When employment increases, while the capital stock remains constant, the amount of capital available to the average worker will decrease, and labor productivity will fall. © 2001 South-Western, a division of Thomson Learning Growth of the Capital Stock •Investment and the Capital Stock •How to Increase Investment •Human Capital and Economic Growth © 2001 South-Western, a division of Thomson Learning Growth of the Capital Stock An increase in the capital stock causes labor productivity and living standards to increase. © 2001 South-Western, a division of Thomson Learning Growth of the Capital Stock Capital per Worker The total capital stock divided by total employment. © 2001 South-Western, a division of Thomson Learning Growth of the Capital Stock If the capital stock grows faster than employment, then capital per worker will rise, and labor productivity will increase along with it. But if the capital stock grows more slowly than employment, then capital per worker will fall, and labor productivity will fall as well. © 2001 South-Western, a division of Thomson Learning Growth of the Capital Stock As long as investment is greater than depreciation, the total stock of capital will rise. © 2001 South-Western, a division of Thomson Learning Growth of the Capital Stock How to Increase Investment •Increasing the Incentive for Businesses to Invest •Increasing the Incentive for Households to Save •Shrinking the Government’s Budget © 2001 South-Western, a division of Thomson Learning Growth of the Capital Stock Corporate Profits Tax A tax on the profits earned by corporations. Investment Tax Credit A reduction in taxes for firms that invest in certain favored types of capital. © 2001 South-Western, a division of Thomson Learning Growth of the Capital Stock Reducing business taxes or providing specific investment incentives can shift the investment curve rightward, thereby speeding growth in physical capital, and increasing the growth rate of living standards. © 2001 South-Western, a division of Thomson Learning Growth of the Capital Stock Capital Gains Tax A tax on profits earned when a financial asset is sold at more than its acquisition price. Consumption Tax A tax on the part of their income that households spend. © 2001 South-Western, a division of Thomson Learning Growth of the Capital Stock Government can alter the tax and transfer system to increase incentives for saving. If successful, these policies would make more funds available for investment, speed growth in the capital stock, and speed the rise in living standards. © 2001 South-Western, a division of Thomson Learning Growth of the Capital Stock A shrinking deficit or a rising surplus tends to reduce interest rates and increase investment, thus speeding the growth in the capital stock. © 2001 South-Western, a division of Thomson Learning Growth of the Capital Stock Government investment in new capital and in the maintenance of existing capital makes an important contribution to economic growth. © 2001 South-Western, a division of Thomson Learning Growth of the Capital Stock The impact of deficit reduction on economic growth depends on which government programs are cut. Shrinking the deficit by cutting government investment will not stimulate growth as much as would cutting other types of government spending. © 2001 South-Western, a division of Thomson Learning Growth of the Capital Stock Human Capital Skills and knowledge possessed by workers. © 2001 South-Western, a division of Thomson Learning Growth of the Capital Stock An increase in human capital works like an increase in physical capital to increase output: It causes the production function to shift upward, raises productivity, and increases the average standard of living. Technological Change Technological Change The invention or discovery of new inputs, new outputs, or new production methods. © 2001 South-Western, a division of Thomson Learning Technological Change The faster the rate of technological change, the greater the growth rate of productivity, and the faster the rise in living standards. © 2001 South-Western, a division of Thomson Learning Technological Change The rate of technological change in the economy depends largely on firms’ total spending on R&D. Policies that increase R&D spending will increase the pace of technological change. © 2001 South-Western, a division of Thomson Learning Technological Change Patent Protection A government grant of exclusive rights to use or sell a new technology. © 2001 South-Western, a division of Thomson Learning The Cost of Economic Growth •Budgetary Costs •Consumption Costs •Opportunity Costs of Workers’ Time •Sacrifice of Other Social Goals © 2001 South-Western, a division of Thomson Learning The Cost of Economic Growth Promoting economic growth involves unavoidable trade-offs: It requires some groups, or the nation as a whole, to give up something else that is valued. In order to decide how fast we want our economy to grow, we must consider growth’s costs as well as its benefits. © 2001 South-Western, a division of Thomson Learning The Cost of Economic Growth Properly targeted tax cuts can increase the rate of economic growth, but will force us to either redistribute the tax burden or cut government programs. © 2001 South-Western, a division of Thomson Learning The Cost of Economic Growth Greater investment in physical capital, human capital, or R&D will lead to faster economic growth and higher living standards in the future, but we will have fewer consumer goods to enjoy in the present. © 2001 South-Western, a division of Thomson Learning The Cost of Economic Growth An increase in the fraction of the population with jobs or a rise in working hours will increase output and raise living standards, but also requires us to sacrifice time previously spent in nonmarket activities. © 2001 South-Western, a division of Thomson Learning The Cost of Economic Growth We can achieve greater worker safety, a cleaner environment, and other social goals, but we may have to sacrifice some economic growth along the way. Alternatively, we can achieve greater economic growth, but we will have to compromise on other things we care about. © 2001 South-Western, a division of Thomson Learning