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Chapter 25:
The Difference Between
Short-Run and Long-Run
Macroeconomics
Copyright © 2014 Pearson Canada Inc.
Chapter Outline/Learning Objectives
Section
Learning Objectives
After studying this chapter, you will be able to
25.1 Accounting for
Changes in GDP
2.
understand how any change in real GDP can be
decomposed into changes in factor supply, the
utilization rate of factors, and productivity.
3.
understand that short-run changes in GDP are mostly
caused by changes in factor utilization, whereas longrun changes in GDP are mostly caused by changes in
factor supplies and productivity.
4.
explain why macroeconomic policies will only have a
long-run effect on output if they influence the level of
potential output.
25.2 Policy Implications
Copyright © 2014 Pearson Canada Inc.
Chapter 25, Slide 2
25.2 Accounting for Changes in GDP
GDP Accounting: The Basic Principle
Consider the following identity:
GDP = F x (FE/F) x (GDP/FE)
• F is the amount of factors
• FE is the amount of employed factors
What are the three separate terms?
Copyright © 2014 Pearson Canada Inc.
Chapter 25, Slide 3
GDP = F x (FE/F) x (GDP/FE)
1. F is the factor supply.
2. FE/F is the factor utilization rate.
3. GDP/FE is a simple measure of productivity.
Any change in GDP must be associated with a change in one or
more of these things.
How do these three components change over time?
Copyright © 2014 Pearson Canada Inc.
Chapter 25, Slide 4
1. Factor Supplies
• Supplies of labour and capital change only gradually
2. Productivity
• Productivity changes only gradually
3. Factor Utilization Rate
• Fluctuates a lot in the short run
• But very little in the long run
Copyright © 2014 Pearson Canada Inc.
Chapter 25, Slide 5
GDP Accounting: An Application
Consider just one factor of production—labour.
The identity becomes:
GDP = L x (E/L) x (GDP/E)
• L is the labour force
• E/L is the employment rate
• GDP/E is a simple measure of labour productivity
How have these components actually moved in Canada?
Copyright © 2014 Pearson Canada Inc.
Chapter 25, Slide 6
Fig. 25-2
Three Sources of Changes in GDP
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Chapter 25, Slide 7
Summing Up
To understand long-run changes in GDP:
• need to understand labour force growth and
productivity growth
To understand short-run changes in GDP:
• need to understand changes in the utilization rate
of labour—the employment rate
Copyright © 2014 Pearson Canada Inc.
Chapter 25, Slide 8
25.3 Policy Implications
Fiscal and monetary policies affect the short run level of GDP
because they alter the level of aggregate demand.
But unless they are able to affect the level of potential output,
they will have no effect on long-run GDP.
• broad consensus that monetary policy has only limited
effects on Y*
• fiscal policy probably has more effects on Y*
Copyright © 2014 Pearson Canada Inc.
Chapter 25, Slide 9
Review
GDP can be represented by the equation: GDP = L x [E/L] x [GDP/E]
where L is the total supply of labour and E is the level of
employment. In this equation, the term [GDP/E] represents
A) output per unit of capital.
B) the productivity of labour.
C) the unemployment rate.
D) the ratio of the population unemployed.
E) one minus the unemployment rate.
© 2014 Pearson Education Canada Inc.
10
Review
Consider a small economy where factor supply is 1000 units, the
factor utilization rate is 0.9 and a simple measure of productivity
(GDP per factor employed) is $80. This economy's GDP is
A) $72 000
B) $88 888
C) $7200
D) $90 000
E) $80 000
© 2014 Pearson Education Canada Inc.
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Chapter 26:
Long-Run
Economic Growth
Copyright © 2014 Pearson Canada Inc.
Chapter Outline/Learning Objectives
Section
Learning Objectives
After studying this chapter, you will be able to
26.1 The Nature of
Economic Growth
1.
discuss the costs and benefits of economic growth.
2.
list four important determinants of growth in real GDP.
26.2 Established Theories
of Economic Growth
3.
explain the main elements of Neoclassical growth
theory in which technological change is exogenous.
26.3 Newer Growth
Theories
4.
discuss alternative growth theories based on
endogenous technical change.
26.4 Are There Limits
to Growth?
5.
explain why resource exhaustion and environmental
degradation may create serious challenges for public
policy directed at sustaining economic growth.
Copyright © 2014 Pearson Canada Inc.
Chapter 26, Slide13
26.1 The Nature of Economic Growth
Sustained increases in Y* are a more powerful method of raising
material living standards than the removal of recessionary gaps.
Even small differences in annual growth rates can result in large
changes in living standards after many years.
Consider GDP, per capita GDP, and GDP per worker.
Copyright © 2014 Pearson Canada Inc.
Chapter 26, Slide14
Measuring Growth
A growth rate is the annual percentage change of a variable. One
measure of economic growth is Real GDP Growth Rate.
Real GDP Growth Rate = Real GDP t – Real GDP t-1 X 100
Real GDP t-1
The growth rate of real GDP tells us how rapidly the TOTAL economy
is expanding.
© 2014 Pearson Education Canada Inc.
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Per Capita Real GDP
To determine if a country's standard of living is improving, economist
use Real GDP per capita.
Real GDP Per Capita = Real GDP
Population
The contribution of Real GDP growth to the change in standard of
living depends on the growth rate of of Real GDP Per Capita.
Real GDP/Capita Growth = Real GDP/capita t – Real GDP/capita t-1
Real GDP t-1
X 100
Real GDP per capita grows only if the real GDP grows fater than the
population!
© 2014 Pearson Education Canada Inc.
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What Determines Potential GDP?
As we saw in Chapter 25, land, labour, capital (and entrepreneurship)
produce Real GDP, and the productivity of the factors determines the
amount of Reap GDP that can be produced.
Labour productivity is the quantity of real GDP produced by an hour
of labour.
Labour Productivity = = Real GDP
Aggregate labour hours
Example: if real GDP is $1,400 Billion and aggregate labour hours are
20 billion, then labour productivity is $65 per hour.
© 2014 Pearson Education Canada Inc.
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Conditions for Labour Productivity Growth
1.
Physical Capital Growth
- As the amount of capital per worker increases, labour productivity also increases
2.
Human Capital Growth
- Remember human capital is the accumulated skill and knowledge of human
beings
3.
Technological Advances
- the discovery and application of new technologies has contributed greatly to
labour productivity
- technological advances arises from formal research and development programs,
trial and error, and discovering new ways to get more out of our resources
© 2014 Pearson Education Canada Inc.
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Benefits of Economic Growth
1. Rising average living standards
2. Alleviation of poverty
•
many do not share directly in the growth
•
but redistribution is easier in a growing economy
APPLYING ECONOMIC CONCEPTS 26-1
A Case Against Economic Growth
Copyright © 2014 Pearson Canada Inc.
Chapter 26, Slide19
Costs of Economic Growth
1. Sacrifice of Current Consumption
•
growth is often encouraged by increasing investment
and saving
•
which requires less consumption
2. Social Costs of Growth
•
growth usually involves the displacement of some firms
and workers
•
this process involves real transition costs
Copyright © 2014 Pearson Canada Inc.
Chapter 26, Slide20
Sources of Economic Growth
The four fundamental sources of economic growth are:
1. Growth in the labour force
2. Growth in human capital
3. Growth in physical capital
4. Technological improvement
Different theories emphasize different sources of growth.
Copyright © 2014 Pearson Canada Inc.
Chapter 26, Slide21
Neoclassical Growth Theory
This theory begins with the idea of an aggregate production function:
GDP = FT(L,K,H)
• L is the total amount of labour
• K is the stock of physical capital
• H is the quality of human capital
• T is the state of technology
The notation FT reflects the assumption that changes in technology
will change the production function.
Copyright © 2014 Pearson Canada Inc.
Chapter 26, Slide 22
In the Neoclassical growth model, technological change is necessary
for sustained growth in living standards.
Much technological change is embodied in new capital equipment
 investment is crucial
Measuring the extent of technological change is difficult—because it
is not directly observable.
Copyright © 2014 Pearson Canada Inc.
Chapter 26, Slide 23
Robert Solow (MIT)
• his "growth accounting" method estimates technical change as
the part of growth that is unexplained by capital accumulation
or labour-force growth.
 the "Solow Residual"
LESSONS FROM HISTORY 26-1
Should Workers Be Afraid of Technological Change?
Copyright © 2014 Pearson Canada Inc.
Chapter 26, Slide 24
26.3 Newer Growth Theories
Endogenous Technological Change
New growth theory emphasizes the process of innovation and the
incorporation of new technology:
• learning-by-doing
• knowledge transfer
• market structure and innovation
• shocks and innovation
Copyright © 2014 Pearson Canada Inc.
Chapter 26, Slide 25
Increasing Marginal Returns
New growth theories also emphasize the possibility that each new
increment of investment is more productive than the last.
• contrasts with the Neoclassical assumption of diminishing
marginal returns.
The sources of increasing returns usually fall into one of two
categories:
• market-development costs
• increasing returns to knowledge
Copyright © 2014 Pearson Canada Inc.
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26.4 Are There Limits to Growth?
Resource Exhaustion
Current technology and resources could not support the entire world's
population at the average Canadian standard of living.
• but absolute limits to growth may not be relevant
• technology is constantly improving, suggesting that living
standards can continually improve
• but technological improvements are not automatic—
they do not "just happen"
Copyright © 2014 Pearson Canada Inc.
Chapter 26, Slide 27
Environmental Degradation
Conscious management of pollution was unnecessary when the
world's population was one billion people, but such management has
now become a pressing matter.
Conclusion
Growth can help the world address many problems. But further
growth must be sustainable growth, which should be based on
knowledge-driven technological change.
APPLYING ECONOMIC CONCEPTS 26-2
Climate Change and Economic Growth
Copyright © 2014 Pearson Canada Inc.
Chapter 26, Slide 28
Review
A person who returns to school to improve her computer skills is an
example of an increase in
A) technological capital.
B) the labour force.
C) physical capital.
D) financial capital.
E) human capital.
© 2014 Pearson Education Canada Inc.
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Review
In the Neoclassical growth model, if capital and labour grow at the
same rate, we will observe
A) increasing living standards but only for workers using capitalintensive production.
B) rising GDP and increasing living standards.
C) increasing living standards but only for workers using labourintensive production.
D) rising GDP but no change in living standards.
E) rising GDP but falling living standards.
© 2014 Pearson Education Canada Inc.
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