Download Economics R. Glenn Hubbard, Anthony Patrick O`Brien, 2e.

7
C HAPTE R
Introduction to Economic Growth and
Instability
Learning Objective 10.1
http://www.uwyo.edu/askiba/macro.asp
Economic Growth Over Time and Around the World
Economic Growth from 1,000,000 B.C. to the Present
FIGURE 10-1
Average Annual
Growth Rates for
the World Economy
Learning Objective 10.1
Economic Growth Over Time and Around the World
“The Rich Get Richer and . . . ”
FIGURE 10-2
GDP per Capita, 2006
Learning Objective 9.1
Long-Run Economic Growth
Long-run economic growth The process by which rising
productivity increases the average standard of living.
FIGURE 9.1
The Growth in Real GDP
per Capita, 1900–2006
Learning Objective 9.1
Long-Run Economic Growth
FIGURE 9.2
Potential GDP The level of
GDP attained when all firms are
producing at capacity.
Actual and Potential Real GDP
Business cycle Alternating
periods of economic expansion
and economic recession.
Learning Objective 9.1
Making
the
Connection
The Connection between
Economic Prosperity and Health
Learning Objective 10.1
Economic Growth Over Time and Around the World
Small Differences in Growth Rates Are Important
In the long run, small differences in
economic growth rates result in big
differences in living standards.
Why Do Growth Rates Matter?
Growth rates matter because an
economy that grows too slowly fails
to raise living standards.
Don’t Let This Happen to YOU!
Don’t Confuse the Average Annual Percentage
Change with the Total Percentage Change
Learning Objective 10.1
Making The Benefits of an Earlier Start:
the
Connection
Standards of Living in China and Japan
CHINA
Sustained high rates of economic
growth have helped Japan attain
high living standards.
JAPAN
Life expectancy at birth
71.9 years
82.2 years
Infant mortality (per
1,000 live births)
23
3
Percentage of the
population surviving on
less than $2 per day
47%
0%
Percentage of the
population with access
to treated water
77%
100%
Percentage of the
population with access
to improved sanitation
44%
100%
Internet users per 1,000
people
73
587
Learning Objective 9.1
Long-Run Economic Growth
Calculating Growth Rates and the Rule of 70
Number of years to double 
70
Growth rate
Learning Objective 10.2
What Determines How Fast Economies Grow?
Labor productivity The quantity of goods
and services that can be produced by one
worker or by one hour of work.
Technological change A change in the
quantity of output a firm can produce using
a given quantity of inputs.
Learning Objective 10.2
What Determines How Fast Economies Grow?
There are three main sources of technological change:
• Better machinery and equipment.
• Increases in human capital.
Human capital The accumulated
knowledge and skills that workers
acquire from education and training
or from their life experiences.
• Better means of organizing and
managing production.
Learning Objective 10.2
What Determines How Fast Economies Grow?
Which Is More Important for Economic Growth:
More Capital or Technological Change?
The Per-Worker Production Function
FIGURE 10-3
The Per-Worker Production Function
Learning Objective 10.2
What Determines How Fast Economies Grow?
Technological Change:
The Key to Sustaining Economic Growth
FIGURE 10-4
Technological Change
Increases Output per
Hour Worked
Learning Objective 10.2
What Determines How Fast Economies Grow?
If technological change is the key to growth then what
encourages the technological change
New growth theory: “incentives and
market system”
Learning Objective 10.2
Making
the
Connection
Why Did the Soviet Union’s
Economy Fail?
The fall of the Berlin Wall
in 1989 symbolized the
failure of Communism.
Learning Objective 10.2
What Determines How Fast Economies Grow?
New Growth Theory
Government policy can help increase the accumulation of
knowledge capital in three ways:
• Protecting intellectual property with patents
and copyrights.
Patent The exclusive right to a
product for a period of 20 years from
the date the product is invented.
• Subsidizing research and development.
• Subsidizing education.
Learning Objective 10.4
Why Isn’t the Whole World Rich?
Catch-up: Sometimes, but Not Always
Catch-up Among the Industrial Countries
FIGURE 10-8
There Has Been Catch-up
among Industrial Countries
Learning Objective 10.4
Why Isn’t the Whole World Rich?
Catch-up: Sometimes, but Not Always
Are the Developing Countries Catching Up to the Industrial
Countries?
FIGURE 10-9
Most of the World Hasn’t
Been Catching Up
Learning Objective 10.4
Why Isn’t the Whole World Rich?
Why Don’t More Low-Income Countries
Experience Rapid Growth?
Failure to Enforce the Rule of Law
Property rights The rights individuals
or firms have to the exclusive use of
their property, including the right to buy
or sell it.
Rule of law The ability of a government
to enforce the laws of the country,
particularly with respect to protecting
private property and enforcing contracts.
Learning Objective 10.4
Why Isn’t the Whole World Rich?
Why Don’t More Low-Income Countries
Experience Rapid Growth?
Failure to Enforce the Rule of Law
FIGURE 10-10
The Rule of Law and Growth
Learning Objective 10.4
Why Isn’t the Whole World Rich?
Why Don’t More Low-Income Countries
Experience Rapid Growth?
Wars and Revolutions
Wars have made it impossible for countries
such as Afghanistan, Angola, Ethiopia, the
Central African Republic and the Congo to
accumulate capital or adopt new technologies.
Learning Objective 10.4
Why Isn’t the Whole World Rich?
Why Don’t More Low-Income Countries
Experience Rapid Growth?
Poor Public Education and Health
Many low-income countries have weak public
school systems, so many workers are unable to
read and write.
People who are sick work less and are less
productive when they do work.
Low Rates of Saving and Investment
The low savings rates in developing countries
contribute to a vicious cycle of poverty.
Learning Objective 10.4
Why Isn’t the Whole World Rich?
The Benefits of Globalization
FIGURE 10-11
Globalization and Growth
Learning Objective 10.5
Growth Policies
We have seen that even small differences in growth rates
compounded over the years can lead to major differences
in standards of living.
Therefore, there is potentially a very high payoff to
government policies that increase growth rates.
Enhancing Property Rights and the Rule of Law
Improving Health and Education
Policies with Respect to Technology
Policies with Respect to Saving and Investment
Is Economic Growth Good or Bad?
ECONOMIC GROWTH
How to increase the economy’s productive
capacity over time.
Two definitions of economic growth:
The increase in real GDP, which occurs over a period of time.
The increase in real GDP per capita, which occurs over time.
Per-capita GDP = GDP/population
(the share of each inhabitant of the GDP on average)
This definition is superior if comparison of living
standards is desired.
e.g.,
China’s 2001 GDP was $1131 billion compared to
Kuwait’s $36 billion,
But per capita GDP’s were $890 and $18000
respectively.
Growth in real GDP does not guarantee growth in real GDP per
capita.
If the growth in population exceeds the growth in real GDP, real
GDP per capita will fall (lower standards of living).
Expansion of total output relative to population results in:
Rising real wages and income
Higher standards of living
Growth as a Goal
Growth is an important economic goal because it means more
material abundance and ability to meet the economizing
problem.
Arithmetic of Growth: Rule of 70
The “rule of 70” uses the absolute value of a rate of
change, divides it into 70, to tell us about the number of
years it will take for some measure to double (in compound
rates).
e.g.,
If growth rate = 3%. It will take 23 years to double GDP
Small changes in the rate of growth are important.
If the rate of growth increased to 4%. It will take about 18 years only to
double GDP.
In USA with a $12.5 trillion GDP, the difference between the rate of 3%
and 4% equals 125 billion.
Main sources of growth
Sources:
Increasing inputs of resources
Increasing productivity of resources
productivity = real output per unit of input
e.g., productivity of labor
productivity of labor = real output / No. labor units
How can we improve productivity of labor??
Two thirds of growth in USA result from improved productivity. Only one-third of
U.S. growth comes from more inputs
The rate of growth of real GDP in Kuwait
year GDP constant GDP current Growth of real
prices
prices
GDP
1993
1994
1995
1996
1997
1998
1999
2000
8702.5
7379.8
9453.2
8113.9
9583.4
9429.1
9323.9
9206.7
9435.2
7906.5
9733.2
9169.7
9255.2
11356.7
9946.1
10445.7
average
33.759
8.626
1.377
-2.708
1.194
3.158
-4.911
7.465
5.995
Note: Growth rate excluding 1993 equals 2.029
War and
liberation
effect
Main Sources of Growth
Society can increase its real output growth by:
Increasing its inputs of resources (Quantity).
Increasing productivity of resources (Quality).
(Productivity: real output per unit of input)
Productivity rises with:
1) improvement in: health, training, education, and
motivation of workers.
2) use of more and better machines and resources.
3) better organization and management of production.
4) reallocation of labor from less to more efficient firms.
The Business Cycle
Fluctuations in economic activity
Individual cycles vary substantially in duration and intensity:
- short cycle
- medium cycle
- long term cycle
THE BUSINESS CYCLE
Phases of the Business Cycle
RECESSION
TROUGH
Level of business activity
PEAK
Time
RECOVERY
Phases of the Business Cycle
Four phases of the business cycle are identified over a several-year
period.
A peak is when business activity reaches a temporary maximum
with near/full employment and near full capacity output.
At peak:
Full employment
Real output is close to capacity
Prices likely to be high
A recession
There is a decline in total output, income, and employment, lasting
six months or more.
It is marked by a widespread concentration of business activity in
many sectors of the economy
Prices fall only if a depression occurs
(many prices are sticky)
A trough (recession or depression)
is the bottom of the recession period. Output and employment
bottom out at their lowest levels
A recovery
is when output and employment are expanding toward the
full-employment level. Price level may increase before full
employment.
There are several theories about causation
Momentous innovations:
Major innovations may trigger new investment and/or
consumption spending.
railroads, automobiles, and micro-chips, have great impact on
investment spending and thus on output, employment
and prices.
Contribute to variability of economic activity
Changes in productivity may be a related cause:
When productivity expands, the economy booms.
When productivity falls the economy recedes.
Monetary causes:
Too much money leads to inflationary boom
Too little money triggers recession
Changes in total spending:
Most economists agree that the level of aggregate spending is
important, especially changes on capital goods and consumer
durables.
When total spending sinks, output, income and employment fall.
When total spending rises, output, income and employment rise.
Cyclical Impact: Durables and Nondurables
Durable goods output is more volatile than non-durables and services
because spending on the latter usually cannot be postponed. Capital
goods and consumer durables are affected the most.
In recessions, firms delay the purchase of new machines and equipments
and consumers repair their old appliances.
In booms, firms replace their capital and consumers buy new appliances.
Nondurable consumer goods are little affected by recessions.