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CHAPTER
30
Long-Run Growth
Prepared by: Fernando Quijano
and Yvonn Quijano
© 2004 Prentice Hall Business Publishing
Principles of Economics, 7/e
Karl Case, Ray Fair
C H A P T E R 30: Long-Run Growth
Long-Run Growth
• Economic growth refers to an
increase in the total output of an
economy. Defined by some
economists as an increase of real
GDP per capita.
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Karl Case, Ray Fair
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C H A P T E R 30: Long-Run Growth
Long-Run Growth
• Modern economic growth is the
period of rapid and sustained
increase in real output per capita that
began in the Western World with the
Industrial Revolution.
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Karl Case, Ray Fair
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C H A P T E R 30: Long-Run Growth
The Growth Process:
From Agriculture to Industry
• The production possibility
frontier (ppf) shows all the
combinations of output that
can be produced if all
society’s scarce resources
are fully and efficiently
employed.
• Economic growth expands
society’s production
possibilities, shifting the
ppf up and to the right.
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Karl Case, Ray Fair
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C H A P T E R 30: Long-Run Growth
The Growth Process:
From Agriculture to Industry
• Before the Industrial Revolution in Great
Britain, every society in the world was
agrarian.
• Beginning in England around 1750,
technical change and capital accumulation
increased productivity in two important
industries: agriculture and textiles.
• More could be produced with fewer
resources, leading to new products, more
output, and wider choice.
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C H A P T E R 30: Long-Run Growth
The Sources of Economic Growth
•
An aggregate production
function is the mathematical
representation of the relationship
between inputs and national output,
or gross domestic product.
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C H A P T E R 30: Long-Run Growth
The Sources of Economic Growth
•
If you think of GDP as a function of
both labor and capital, you can see
that an increase in GDP can come
about through:
1. An increase in the labor supply
2. An increase in physical or human
capital
3. An increase in productivity (the amount
of product produced by each unit of
capital or labor)
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C H A P T E R 30: Long-Run Growth
An Increase in Labor Supply
• An increasing labor supply can
generate more output, but if the
capital stock remains fixed, the new
labor will be less productive
(diminishing returns).
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Karl Case, Ray Fair
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C H A P T E R 30: Long-Run Growth
An Increase in Labor Supply
• Malthus and Ricardo predicted a
gloomy future as population
outstripped the land’s capacity to
produce. However, they forgot the
impact of technological change and
capital accumulation.
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Karl Case, Ray Fair
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C H A P T E R 30: Long-Run Growth
An Increase in Labor Supply
• Growth in the labor force, without a
corresponding increase in the
capital stock or technological
change, might lead to growth of
output but declining productivity and
a lower standard of living.
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C H A P T E R 30: Long-Run Growth
An Increase in Labor Supply
Economic Growth from an Increase in Labor – More Output but
Diminishing Returns and Lower Labor Productivity
PERIOD
QUANTITY
OF LABOR
L
(HOURS)
QUANTITY
OF CAPITAL
K
(UNITS)
TOTAL
OUTPUT
Y
(UNITS)
MEASURED
LABOR
PRODUCTIVITY
Y/L
1
100
100
300
3.0
2
110
100
320
2.9
3
120
100
339
2.8
4
130
100
357
2.7
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C H A P T E R 30: Long-Run Growth
An Increase in Labor Supply
• Labor productivity is the output per
worker hour; the amount of output
produced by an average worker in 1
hour.
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C H A P T E R 30: Long-Run Growth
An Increase in Labor Supply
Employment, Labor Force, and Population Growth, 1947 – 2002
CIVILIAN
CIVILIAN
NONINSTITUTIONAL
LABOR
POPULATION
FORCE
OVER 16 YEARS OLD Number
Percentage EMPLOYMENT
(MILLIONS)
(Millions) of Population (MILLIONS)
1947
101.8
59.4
58.3
57.0
1960
117.3
69.6
59.3
65.8
1970
137.1
82.8
60.4
78.7
1980
167.7
106.9
63.7
99.3
1990
189.2
125.8
66.5
118.8
2002
214.0
142.5
66.6
134.3
+ 110.2
+ 139.9
Percentage change, 1947 – 2002
Annual rate
+ 1.4%
+ 135.6
+1.6%
+ 1.6%
Source: Economic Report of the President, 2003, Table B-35.
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Principles of Economics, 7/e
Karl Case, Ray Fair
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C H A P T E R 30: Long-Run Growth
An Increase in Labor Supply
• As long as the economy and the
capital stock are expanding rapidly
enough, new entrants into the labor
force do not displace other workers.
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C H A P T E R 30: Long-Run Growth
Increases in Physical Capital
• An increase in the stock of capital
can increase output, even if it is not
accompanied by an increase in the
labor force.
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C H A P T E R 30: Long-Run Growth
Increases in Physical Capital
Economic Growth from an Increase in Capital – More Output, Diminishing
Returns to Added Capital, Higher Measured Labor Productivity
PERIOD
QUANTITY
OF LABOR
L
(HOURS)
QUANTITY
OF CAPITAL
K
(UNITS)
TOTAL
OUTPUT
Y
(UNITS)
MEASURED
LABOR
PRODUCTIVITY
Y/L
1
100
100
300
3.0
2
100
110
310
3.1
3
100
120
319
3.2
4
100
130
327
3.3
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C H A P T E R 30: Long-Run Growth
Increases in Physical Capital
• The increase in capital stock is the
difference between gross investment
and depreciation.
• Capital has been increasing faster
than the labor force since 1960.
When capital expands more rapidly
than labor, the ratio of capital to labor
(K/L) increases, and this too is a
source of increasing productivity.
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C H A P T E R 30: Long-Run Growth
Increases in Physical Capital
Fixed Private Nonresidential Net Capital Stock, 1960 – 2001
(Billions of 1996 Dollars)
EQUIPMENT
STRUCTURES
1960
672.7
2,015.7
1970
1,154.8
2,744.2
1980
1,989.8
3,589.1
1990
2,722.5
4,703.5
2001
4,480.0
5,682.5
Percentage change, 1960 – 2001
+ 566.0
+ 181.9
Annual rate
+ 4.7%
+ 2.6%
Source: Survey of Current Business, September 2002, Table 15, p. 37.
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C H A P T E R 30: Long-Run Growth
Increases in Human Capital
Years of School Completed by People Over 25 Years Old, 1940 – 2000
1940
1950
1960
1970
1980
1990
2000
PERCENTAGE
WITH LESS
THAN 5
YEARS OF
SCHOOL
13.7
11.1
8.3
5.5
3.6
NA
NA
PERCENTAGE
WITH 4 YEARS
OF HIGH SCHOOL
OR MORE
24.5
34.3
41.1
52.3
66.5
77.6
84.1
PERCENTAGE
WITH 4 YEARS
OF COLLEGE
OR MORE
4.6
6.2
7.7
10.7
16.2
21.3
25.6
NA = not available.
Source: Statistical Abstract of the United States, 1990, Table 215; and 2002, Table 208.
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Karl Case, Ray Fair
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C H A P T E R 30: Long-Run Growth
Increases in Productivity
• Growth that cannot be explained by
increases in the quantity of inputs
can be explained only by an increase
in the productivity of those inputs.
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C H A P T E R 30: Long-Run Growth
Increases in Productivity
• The productivity of an input is the
amount produced per unit of an
input.
• Factors that affect the productivity of
an input include technological
change, other advances in
knowledge, and economies of scale.
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C H A P T E R 30: Long-Run Growth
Increases in Productivity
•
•
Technological change affects
productivity in two stages:
•
First there is an advance in knowledge,
or an invention.
•
Then there is innovation, or the use of
new knowledge to produce a new
product or to produce an existing
product more efficiently.
There are capital-saving innovations,
and labor-saving innovations.
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C H A P T E R 30: Long-Run Growth
Increases in Productivity
•
External economies of scale are
cost savings that result from
increases in the size of industries.
•
Production abatement requirements
divert capital and labor from the
production of measured output,
therefore reducing measured
productivity.
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C H A P T E R 30: Long-Run Growth
Growth and Productivity
in the United States
Growth of Real GDP in the United States, 1871 – 2000
PERIOD
AVERAGE
GROWTH
RATE
PER YEAR
PERIOD
AVERAGE
GROWTH
RATE
PER YEAR
1871-1889
5.5
1950-1960
3.5
1889-1909
4.0
1960-1970
4.2
1909-1929
2.8
1970-1980
3.2
1929-1940
1.6
1980-1990
3.2
1940-1950
5.6
1990-2000
3.2
Sources: Historical Statistics of the United States: Colonial Times to 1970, Tables F47-70, F98-124; U.S. Department of Commerce, Bureau of
Economic Analysis.
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C H A P T E R 30: Long-Run Growth
Growth and Productivity
in the United States
Growth of Real GDP in the United States and
Other Countries, 1981 – 1998
AVERAGE
GROWTH RATE
PER YEAR
COUNTRY
United States
Japan
Germany
France
Italy
United Kingdom
Canada
Africa
Asia (excluding Japan)
3.2
2.3
2.2
2.1
2.0
2.6
3.1
2.7
7.2
Source: Economic Report of the President, 2002, computed from Table B-112.
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Karl Case, Ray Fair
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C H A P T E R 30: Long-Run Growth
Sources of Growth in the
U.S. Economy, 1929 – 1982
Sources of Growth in the United States, 1929 – 1982
PERCENT OF GROWTH ATTRIBUTABLE TO EACH SOURCE
1929 – 1982
1929 – 1948
1948 – 1973
1973 – 1979
53
49
45
94
Labor
20
26
14
47
Capital
14
3
16
29
Education (human capital)
19
20
15
18
Increases in productivity
47
51
55
6
Advances in knowledge
31
30
39
8
Other factorsa
16
21
16
-2
Increases in inputs
Annual growth rate
in real national
income
2.8
2.4
3.6
2.6
aEconomies
of scale, weather, pollution abatement, worker safety and health, crime, labor disputes, and so forth.
Source: Edward Denison, Trends in American Economic Growth, 1929 – 1982 (Washington: Brookings Institution, 1985).
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C H A P T E R 30: Long-Run Growth
Labor Productivity: 1952 – 2003
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C H A P T E R 30: Long-Run Growth
Labor Productivity: 1952 – 2003
• Some of the explanations for the
slowdown in productivity growth in
the 1970s include:
• A low rate of saving
• Increased environmental and
government regulations
• Lack of spending in R&D
• High energy costs
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C H A P T E R 30: Long-Run Growth
Labor Productivity: 1952 – 2003
• Many of these factors turned around
in the 1980s and 1990s, yet
productivity growth remained low.
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C H A P T E R 30: Long-Run Growth
Economic Growth and Public Policy
• Policy provisions to improve the
quality of education include the new
Education Individual Retirement
Account that allows savings to earn
tax free returns as long as the
balance is used to pay for
educational expenses.
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C H A P T E R 30: Long-Run Growth
Economic Growth and Public Policy
• Policies to increase the saving rate
include individual retirement
accounts that accumulate earnings
without paying income tax.
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C H A P T E R 30: Long-Run Growth
Economic Growth and Public Policy
• The amount of capital accumulation
is ultimately constrained by its rate of
saving.
• The tax system and the social
security system in the United States
are biased against saving.
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C H A P T E R 30: Long-Run Growth
Economic Growth and Public Policy
• Some public finance economists
favor shifting to a system of
consumption taxation rather than
income taxation to reduce the tax
burden on saving.
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C H A P T E R 30: Long-Run Growth
Economic Growth and Public Policy
• Other public policies to stimulate
economic growth include:
• Policies to stimulate investment
• Policies to increase research and
development
• Reduced regulations
• Industrial policy, or government
involvement in the allocation of capital
across manufacturing sectors.
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C H A P T E R 30: Long-Run Growth
The Progrowth Argument
• Advocates of growth believe growth
is progress.
• New technologies and production
methods lead to new and better
products. Capital accumulation and
new technology improve the quality
of life.
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C H A P T E R 30: Long-Run Growth
The Progrowth Argument
• Growth saves the most valuable
commodity—time.
• Growth also improves the quality of
things that yield satisfaction directly.
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C H A P T E R 30: Long-Run Growth
The Progrowth Argument
• Growth produces jobs and higher
incomes. With higher incomes we
can better afford the sacrifices
needed to help the poor.
• When population growth is not
accompanied by growth in output,
unemployment and poverty increase.
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C H A P T E R 30: Long-Run Growth
The Antigrowth Argument
• Growth has negative effects on the
quality of life.
• Growth encourages the creation of
artificial needs.
• Consumer sovereignty is the notion
that people are free to choose, and that
things that people do not want will not
sell. “The consumer rules.”
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C H A P T E R 30: Long-Run Growth
The Antigrowth Argument
• Growth means the rapid depletion of
a finite quantity of resources.
• Growth requires an unfair income
distribution and propagates it.
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C H A P T E R 30: Long-Run Growth
Review Terms and Concepts
aggregate production function
invention
consumer sovereignty
labor productivity
economic growth
modern economic growth
industrial policy
productivity of an input
innovation
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