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Chapter 18 Long-Run Growth Prepared by: Fernando & Yvonn Quijano © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair CHAPTER 18: Long-Run Growth Long-Run Growth 18 Chapter Outline The Growth Process: From Agriculture to Industry The Sources of Economic Growth An Increase in Labor Supply Increases in Physical Capital Increases in Human Capital Increases in Productivity Growth and Productivity in the United States Sources of Growth in the U.S. Economy: 1929–1982 Labor Productivity: 1952 I–2005 II Economic Growth and Public Policy Suggested Public Policies Growth Policy: A Long-Run Proposition The Pros and Cons of Growth The Progrowth Argument The Antigrowth Argument Summary: No Right Answer © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 2 of 38 CHAPTER 18: Long-Run Growth LONG-RUN GROWTH economic growth An increase in the total output of an economy. Defined by some economists as an increase of real GDP per capita. modern economic growth The period of rapid and sustained increase in real output per capita that began in the Western world with the Industrial Revolution. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 3 of 38 CHAPTER 18: Long-Run Growth THE GROWTH PROCESS: FROM AGRICULTURE TO INDUSTRY FIGURE 18.1 Economic Growth Shifts Society’s Production Possibility Frontier Up and to the Right © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 4 of 38 THE GROWTH PROCESS: FROM AGRICULTURE TO INDUSTRY CHAPTER 18: Long-Run Growth From Agriculture to Industry: The Industrial Revolution Beginning in England around 1750, technical change and capital accumulation increased productivity significantly in two important industries: agriculture and textiles. More could be produced with fewer resources, leading to new products, more output, and wider choice. A rural agrarian society was very quickly transformed into an urban industrial society. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 5 of 38 CHAPTER 18: Long-Run Growth Among the sources of increased productivity and growth in England around 1750 was: a. Technical change and capital accumulation. b. New and more efficient methods of farming. c. New inventions and new machinery. d. All of the above. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 6 of 38 CHAPTER 18: Long-Run Growth Among the sources of increased productivity and growth in England around 1750 was: a. Technical change and capital accumulation. b. New and more efficient methods of farming. c. New inventions and new machinery. d. All of the above. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 7 of 38 THE GROWTH PROCESS: FROM AGRICULTURE TO INDUSTRY CHAPTER 18: Long-Run Growth Growth in Modern Society Economic growth continues today, and while the underlying process is still the same, the face is different. Growth comes from a bigger workforce and more productive workers. Higher productivity comes from tools (capital), a better-educated and more highly skilled workforce (human capital), and increasingly from innovation and technical change (new techniques of production) and newly developed products and services. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 8 of 38 CHAPTER 18: Long-Run Growth THE SOURCES OF ECONOMIC GROWTH aggregate production function The mathematical representation of the relationship between inputs and national output, or gross domestic product. 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) © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 9 of 38 THE SOURCES OF ECONOMIC GROWTH CHAPTER 18: Long-Run Growth AN INCREASE IN LABOR SUPPLY TABLE 18.1 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 2 3 4 100 110 120 130 100 100 100 100 300 320 339 357 3.0 2.9 2.8 2.7 labor productivity Output per worker hour; the amount of output produced by an average worker in 1 hour. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 10 of 38 THE SOURCES OF ECONOMIC GROWTH CHAPTER 18: Long-Run Growth TABLE 18.2 Employment, Labor Force, and Population Growth, 1947–2004 CIVILIAN NONINSTITUTIONAL POPULATION OVER 16 YEARS OLD (MILLIONS) Number (Millions) Percentage of Population 101.8 117.3 137.1 167.7 189.2 212.6 223.4 + 119.4% 59.4 69.6 82.8 106.9 125.8 142.6 147.4 + 148.1% 58.3 59.3 60.4 63.7 66.5 67.1 66.0 + 1.4% +1.6% 1947 1960 1970 1980 1990 2000 2004 Percentage change, 1947 – 2004 Annual rate CIVILIAN LABOR FORCE EMPLOYMENT (MILLIONS) 57.0 65.8 78.7 99.3 118.8 136.9 139.3 + 144.4% + 1.6% Source: Economic Report of the President, 2005, Table B-35. As long as the economy and the capital stock are expanding rapidly enough, new entrants into the labor force do not displace other workers. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 11 of 38 CHAPTER 18: Long-Run Growth In order for economic growth to increase the standard of living: a. The rate of output growth must exceed the rate of population increase. b. Income must be distributed equally. c. The government must practice industrial policy. d. Citizens must experience improvements in the quality of life. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 12 of 38 CHAPTER 18: Long-Run Growth In order for economic growth to increase the standard of living: a. The rate of output growth must exceed the rate of population increase. b. Income must be distributed equally. c. The government must practice industrial policy. d. Citizens must experience improvements in the quality of life. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 13 of 38 THE SOURCES OF ECONOMIC GROWTH CHAPTER 18: Long-Run Growth INCREASES IN PHYSICAL CAPITAL TABLE 18.3 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 © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 14 of 38 THE SOURCES OF ECONOMIC GROWTH CHAPTER 18: Long-Run Growth TABLE 18.4 Fixed Private Nonresidential Net Capital Stock, 1960–2003 (Billions of 2000 Dollars) EQUIPMENT STRUCTURES 1960 645.7 2,273.3 1970 1,108.5 3,094.8 1980 1,910.0 4,047.7 1990 2,613.3 5,304.5 2000 4,138.5 6,287.6 2003 4,523.3 6,525.8 Percentage change, 1960 – 2003 +600.59% +187.1% Annual rate +4.6% + 2.5% Source: Survey of Current Business, September 2004, Table 15, p. 42 and author’s estimates. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 15 of 38 THE SOURCES OF ECONOMIC GROWTH INCREASES IN HUMAN CAPITAL CHAPTER 18: Long-Run Growth TABLE 18.5 Years of School Completed by People Over 25 Years Old, 1940–2003 PERCENTAGE WITH LESS THAN 5 YEARS OF SCHOOL 1940 1950 1960 1970 1980 1990 2000 2003 PERCENTAGE WITH 4 YEARS OF HIGH SCHOOL OR MORE 13.7 11.1 8.3 5.5 3.6 NA NA NA PERCENTAGE WITH 4 YEARS OF COLLEGE OR MORE 24.5 34.3 41.1 52.3 66.5 77.6 84.1 84.6 4.6 6.2 7.7 10.7 16.2 21.3 25.6 27.2 NA = not available. Source: Statistical Abstract of the United States, 1990, Table 215; and 2005, Table 212. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 16 of 38 THE SOURCES OF ECONOMIC GROWTH CHAPTER 18: Long-Run Growth INCREASES IN PRODUCTIVITY productivity of an input The amount of output produced per unit of an input. Technological Change invention An advance in knowledge. innovation The use of new knowledge to produce a new product or to produce an existing product more efficiently. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 17 of 38 CHAPTER 18: Long-Run Growth An increase in GDP can come about through: a. An increase in the labor supply. b. An increase in physical or human capital. c. An increase in productivity (the amount of product produced by each unit of capital or labor). d. All of the above. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 18 of 38 CHAPTER 18: Long-Run Growth An increase in GDP can come about through: a. An increase in the labor supply. b. An increase in physical or human capital. c. An increase in productivity (the amount of product produced by each unit of capital or labor). d. All of the above. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 19 of 38 THE SOURCES OF ECONOMIC GROWTH CHAPTER 18: Long-Run Growth Other Advances in Knowledge In addition to managerial knowledge, improved personnel management techniques, accounting procedures, data management, and the like can also make production more efficient, reduce costs, and increase measured productivity. Economies of Scale External economies of scale are cost savings that result from increases in the size of industries. Other Influences on Productivity © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 20 of 38 GROWTH AND PRODUCTIVITY IN THE UNITED STATES CHAPTER 18: Long-Run Growth TABLE 18.6 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. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 21 of 38 CHAPTER 18: Long-Run Growth The average growth rate of real GDP in the United States was highest during the following period: a. 1950-1960 b. 1960-1970 c. 1970-1980 d. 1980-1990 © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 22 of 38 CHAPTER 18: Long-Run Growth The average growth rate of real GDP in the United States was highest during the following period: a. 1950-1960 b. 1960-1970 c. 1970-1980 d. 1980-1990 © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 23 of 38 GROWTH AND PRODUCTIVITY IN THE UNITED STATES CHAPTER 18: Long-Run Growth TABLE 18.7 Growth of Real GDP in the United States and Other Countries, 1986–2004 COUNTRY AVERAGE GROWTH RATE PER YEAR United States 3.1 Japan 2.3 Germany 2.0 France 2.2 Italy 1.8 United Kingdom 2.7 Canada 2.8 Africa 2.8 Asia (excluding Japan) 9.1 India 5.8 Source: Economic Report of the President, 2005, computed from Table B-112. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 24 of 38 GROWTH AND PRODUCTIVITY IN THE UNITED STATES CHAPTER 18: Long-Run Growth SOURCES OF GROWTH IN THE U.S. ECONOMY: 1929–1982 TABLE 18.8 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). Reprinted with permission of The Brookings Institution. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 25 of 38 GROWTH AND PRODUCTIVITY IN THE UNITED STATES CHAPTER 18: Long-Run Growth TABLE 18.9 Sources of U.S. Growth, 1973–2000 Percent Contribution 1973-1990 Increases in inputs 1990-1995 1995-2000 92 90 83 Labor 40 44 43 Capital 52 46 50 IT capital 14 20 24 Non-IT capital 38 26 26 9 10 17 Increases in productivity Source: Dale Jorgenson and Kazuyuki Motohashi, “Economic Growth of Japan and the United States in the Information Age,” Rieti Discussion Paper Series 3-E-015. Cited with the permission of the authors. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 26 of 38 GROWTH AND PRODUCTIVITY IN THE UNITED STATES CHAPTER 18: Long-Run Growth LABOR PRODUCTIVITY: 1952 I–2003 II FIGURE 18.2 Output per Worker Hour (Productivity), 1952 I–2005 II © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 27 of 38 ECONOMIC GROWTH AND PUBLIC POLICY SUGGESTED PUBLIC POLICIES CHAPTER 18: Long-Run Growth Policies to Improve the Quality of Education Policies to Increase the Saving Rate Policies to Stimulate Investment Policies to Increase Research and Development Reduced Regulations Industrial Policy industrial policy Government involvement in the allocation of capital across manufacturing sectors. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 28 of 38 CHAPTER 18: Long-Run Growth The accumulation of capital in an economy is ultimately constrained by: a. The rate of saving. b. The rate of spending relative to income growth. c. Depreciation. d. Government spending and taxation. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 29 of 38 CHAPTER 18: Long-Run Growth The accumulation of capital in an economy is ultimately constrained by: a. The rate of saving. b. The rate of spending relative to income growth. c. Depreciation. d. Government spending and taxation. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 30 of 38 ECONOMIC GROWTH AND PUBLIC POLICY CHAPTER 18: Long-Run Growth GROWTH POLICY: A LONG-RUN PROPOSITION The fact that progrowth policies can be costly in the short run and do not produce measurable results for a long time often pushes them far down on politicians’ lists of priorities. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 31 of 38 CHAPTER 18: Long-Run Growth What is industrial policy? a. Industrial policy calls for the elimination of government intervention in business activities. b. Industrial policy calls for government involvement in the allocation of capital across manufacturing sectors. c. Industrial policy calls for the promotion of competition among domestic and foreign business firms. d. Industrial policy government spending and taxation that favors all business firms in the economy equally. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 32 of 38 CHAPTER 18: Long-Run Growth What is industrial policy? a. Industrial policy calls for the elimination of government intervention in business activities. b. Industrial policy calls for government involvement in the allocation of capital across manufacturing sectors. c. Industrial policy calls for the promotion of competition among domestic and foreign business firms. d. Industrial policy government spending and taxation that favors all business firms in the economy equally. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 33 of 38 THE PROS AND CONS OF GROWTH CHAPTER 18: Long-Run Growth THE PROGROWTH ARGUMENT Advocates of growth believe that: - - - Growth is progress. Capital accumulation and new technology improve the quality of life. Growth saves the most valuable commodity— time. Growth improves the quality of things that yield satisfaction directly. 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. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 34 of 38 THE PROS AND CONS OF GROWTH CHAPTER 18: Long-Run Growth THE ANTIGROWTH ARGUMENT Those who argue against economic growth generally make the following four major points: Growth Has Negative Effects on the Quality of Life Growth Encourages the Creation of Artificial Needs consumer sovereignty The notion that people are free to choose, and that things that people do not want will not sell. “The consumer rules.” © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 35 of 38 CHAPTER 18: Long-Run Growth THE PROS AND CONS OF GROWTH Growth Means the Rapid Depletion of a Finite Quantity of Resources Growth Requires an Unfair Income Distribution and Propagates It © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 36 of 38 CHAPTER 18: Long-Run Growth SUMMARY: NO RIGHT ANSWER Society must make some hard choices, and there are many trade-offs. As long as these trade-offs exist, people will disagree. The debate in contemporary politics is largely about the costs and benefits of shifting more effort toward the goal of economic growth and away from environmental and social welfare goals. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 37 of 38 CHAPTER 18: Long-Run Growth REVIEW TERMS AND CONCEPTS aggregate production function consumer sovereignty economic growth industrial policy innovation invention labor productivity modern economic growth productivity of an input © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 38 of 38