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AP Macroeconomics Economic Growth & Productivity Economic Growth Defined • Sustained increase in Real GDP over time. • Sustained increase in Real GDP per Capita over time. Why Grow? • Growth leads to greater prosperity for society. • Lessens the burden of scarcity. • Increases the general level of wellbeing. Conditions for Growth • • • • • Rule of Law Sound Legal and Economic Institutions Economic Freedom Respect for Private Property Political & Economic Stability – Low Inflationary Expectations • Willingness to sacrifice current consumption in order to grow • Saving • Trade Physical Capital • Tools, machinery, factories, infrastructure • Physical Capital is the product of Investment. • Investment is sensitive to interest rates and expected rates of return. • It takes capital to make capital. • Capital must be maintained. Technology & Productivity • Research and development, innovation and invention yield increases in available technology. • More technology in the hands of workers increases productivity. • Productivity is output per worker. • More Productivity = Economic Growth. Human Capital • People are a country’s most important resource. Therefore human capital must be developed. • Education • Economic Freedom • The right to acquire private property • Incentives • Clean Water • Stable Food Supply • Access to technology Growth Illustrated PL LRAS SRAS P AD YF GDPR Growth Illustrated PL LRAS SRAS P AD YF GDPR Capital Goods Growth Illustrated or . . PPC Consumer Goods PPC1 Hindrances to Growth • Economic and Political Instability – High inflationary expectations • Absence of the rule of law • Diminished Private Property Rights • Negative Incentives – The welfare state • • • • Lack of Savings Excess current consumption Failure to maintain existing capital Crowding Out of Investment – Government deficits & debt increasing long term interest rates! • Increased income inequality Populist policies • Restrictions on Free International Trade FRQ – 2005 FORM B • 2. Labor productivity is output per unit of labor. An increase • • • • • • • • • in labor productivity is a source of economic growth. (a) Identify two sources of increase in labor productivity. (b) Assume that a country’s economy is at full empl oyment. Productivity has been rising. Using a correctly labeled graph of aggregate demand and aggregate supply, show the long-run effect of the growth in productivity on each of the following. (i) Real output (ii) Price level (c) Assume that the economy produces only two goods, good X and good Y. Using a correctly labeled production possibility diagram, show the effect of the increase in labor productivity