8 Why Do Economies Grow?

ECONOMIC GROWTH RATES capital deepening Increases in the stock of capital per worker. technological progress More efficient ways of organizing economic affairs that allow an economy to increase output without increasing inputs. human capital The knowledge and skills acquired by a worker through education and experience and used to produce goods and services.

ECONOMIC GROWTH RATES What is economic growth? How do we depict economic growth graphically?

CAPITAL DEEPENING  Increase in the Supply of Capital

CAPITAL DEEPENING Why is savings so important to the output of an economy? saving Income that is not consumed. investment Purchase of capital by firms

CAPITAL DEEPENING How do population growth, Government, and trade affect Capital Deepening? What are the limits to Capital Deepening?

SUPPLY–SIDE ECONOMICS “Higher income levels and living standards cannot be achieved without expansion in output. Virtually all economists accept this proposition and therefore are supply siders.” - James D. Gwartney, Prof. Economics FSU Supply-side economics: is used to describe how changes in marginal tax rates influence economic activity. Supply-side economists believe that high marginal tax rates strongly discourage income, output, and the efficiency of resource use.

SUPPLY-SIDE ECONOMICS The Laffer Curve: is a relationship between tax rate and tax revenues that illustrates how higher tax rates may not always lead to higher tax revenues if the high tax rates discourage economic activity.

DEPRECIATION

THE KEY ROLE OF TECHNOLOGICAL PROGRESS How Do We Measure Technological Progress? growth accounting A method to determine the contribution to economic growth from increased capital, labor, and technological progress.

WHAT CAUSES TECHNOLOGICAL PROGRESS? Research and Development Funding  Research and Development as a Percent of GDP, 1999

WHAT CAUSES TECHNOLOGICAL PROGRESS? Monopolies That Spur Innovation creative destruction The view that a firm will try to come up with new products and more efficient ways to produce products to earn monopoly profits. The Scale of the Market Induced Innovations Education, Human Capital, and the Accumulation of Knowledge

A ROLE FORGOVERNMENT : PROVIDING INCENTIVES & PROPERTY RIGHTS What is the connection between property rights and economic growth? Without clear property rights, there are no proper incentives to invest in the future—the essence of economic growth. What else can go wrong? Governments in developing countries often: Adopt policies that effectively tax exports Pursue policies that lead to rampant inflation Enforce laws that inhibit the growth of the banking and financial sectors Results: Fewer exports Uncertain financial environment Reduced saving and investment With the right incentives, individuals and firms in developing countries will take actions that promote economic growth.

 Basic Growth Model Starting at K 0, saving exceeds depreciation. The stock of capital increases. This process continues until the stock of capital reaches its long-run equilibrium at K*. A MODEL OF CAPITAL DEEPENING