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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.
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What Makes
Economies Grow?
Three Most Important Causes
•Increases in Employment
•Increases in the Capital Stock
•Changes in Technology
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Growth in Employment
•How to Increase Employment
•Employment Growth and Productivity
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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).
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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.
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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.
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Growth in Employment
Labor Productivity
Total output (real GDP) per worker.
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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.
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Growth of the Capital Stock
•Investment and the Capital Stock
•How to Increase Investment
•Human Capital and Economic Growth
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Growth of the Capital Stock
An increase in the capital stock causes labor
productivity and living standards to increase.
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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.
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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
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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.
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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.
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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.
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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.
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Growth of the Capital Stock
Government investment in new capital and in
the maintenance of existing capital makes an
important contribution to economic growth.
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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.
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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.
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Technological Change
The faster the rate of technological change,
the greater the growth rate of productivity,
and the faster the rise in living standards.
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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.
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Technological Change
Patent Protection
A government grant of exclusive rights to use
or sell a new technology.
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The Cost of Economic
Growth
•Budgetary Costs
•Consumption Costs
•Opportunity Costs of Workers’ Time
•Sacrifice of Other Social Goals
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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.
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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.
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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