17-2 Economic Growth Economic growth is the fundamental determinant of the long-run success of any nation, the basis source of rising living standards, and the key to meeting the needs of the American people. Economic Report of the President, 1992
17-3 Learning Objectives Know the principal sources of economic growth Know the policy tools for accelerating growth Know the pros and cons of continued growth.
17-4 The Nature of Growth Short-run changes in capacity utilization: – The production possibilities curve (PPC) shows our short-run limit of production capacity. – The economy often produces a mix of output that lies inside the PPC. – The short-run goal is to achieve full employment – that is, to move the economy out to the PPC. We do this by putting to use all of our available resources and our best expertise.
17-5 The Nature of Growth Long-run change in capacity to produce: – To achieve large and lasting increases in output, we must push the PPC outward – that is, to increase our productive capacity. – Economic growth: an increase in output (real GDP); an expansion of production possibilities. – Economic growth is also indicated on an AD-AS diagram as a rightward shift of long-run AS. The natural rate of unemployment then shifts to a higher rate of output (higher real GDP).
17-6 Measures of Growth Growth rate: percentage change in real GDP from one year to the next. – Economic growth is an exponential process. – Small changes compound from year to year. A shortcut method of indicating growth rate is to use the Rule of 72: – To find how many years it takes to double GDP, divide 72 by the growth rate. – At 3.5% growth rate, GDP will double in about 20 years.
17-7 Measures of Growth GDP per capita: total real GDP divided by total population. – This is a measure of living standards. – It increases only when GDP growth exceeds population growth. – In countries where population growth exceeds GDP growth, living standards fall.
17-8 Measures of Growth GDP per worker: real GDP divided by the labor force. – A measure of productivity. – If the labor force grows faster than the population, GDP per capita grows and living standards rise. Productivity is better measured by output per labor-hour. – Increases in GDP per capita over recent decades are due to the rising productivity of the average American worker.
17-9 Sources of Growth Long-run growth of the labor force has stabilized, so continued growth in real GDP must rely on productivity growth. Growth rate of Growth rate of Growth rate of total output = labor force + productivity
17-10 Sources of Growth Higher skills: an increase in labor skills. – Productivity gains reflect more schooling and more on- the-job training. More capital: an increase in the ratio of capital to labor. – This is a primary determinant of labor productivity. – Saving is a basic source of investment financing. – Consumer saving is minuscule; business saving and foreign investment have financed this contribution to our recent productivity gains.
17-11 Sources of Growth Technological advancements: development and use of better capital equipment and products. – Come from research and development (R&D). – Scientific research. – Product development. – Innovations in production techniques. – All of these lead to new products and lower-cost ways of producing them. Improved management: better use of available resources in the production process. – Fostering new entrepreneurship and improving the quality of continuing management.
17-12 New Growth Theory Old growth theory emphasized the importance of saving and investment in new plants and equipment – that is, capital goods. New growth theory emphasizes the importance of investing in ideas. Generating new ideas and the spread of knowledge are the primary engines of growth.
17-13 Policy Tools Increase human capital investment. – Improve the quantity and quality of investment in education. – Encourage employment-based immigration, particularly of those with skills in short supply.
17-14 Policy Tools Increase physical capital investment. – Expand investment incentives: Faster depreciation schedules. Tax credits for new investments. Lower business taxes. – Expand saving incentives. – Expand infrastructure development. – Return to fiscal responsibility. Higher budget deficits lead to crowding out.
17-15 Policy Tools Maintain stable expectations. – Uncertainty about the economic future affects the behavior of both producers and consumers. – The following threats may inhibit investment: Increasing government regulation. Increasing inflation. Increasing budget deficits and crowding out. Increased business taxes.
17-16 Policy Tools Create a favorable institutional context. – Greater economic freedom fosters faster economic growth. Secure property rights. Open international trade. Lower taxes. Less regulation. – This allows for more entrepreneurship and more opportunity and incentive to invest.