ECONOMIC GROWTH CHAPTER-4 ECONOMIC GROWTH CHAPTER-4 1

9.1 The basics of Economic Growth Economic Growth: is a sustained expansion of production possibilities. – Rapid economic growth can transform a poor nation into a rich one. – Slow economic growth or absence of growth can condemn a nation to devastating poverty. Economic Growth: is a sustained expansion of production possibilities. – Rapid economic growth can transform a poor nation into a rich one. – Slow economic growth or absence of growth can condemn a nation to devastating poverty. 2

9.1 The basics of Economic Growth Economic Growth is different from the rise in incomes that occurs during the recovery from a recession. Economic Growth is a sustained trend, not a temporary cyclical expansion. Economic Growth is different from the rise in incomes that occurs during the recovery from a recession. Economic Growth is a sustained trend, not a temporary cyclical expansion. 3

Calculating Growth Rates The Economic Growth rate is the annual percentage change of real GDP. Growth rate of real GDP = Real GDP _ Real GDP in current year in previous year × 100 Real GDP in previous year The Economic Growth rate is the annual percentage change of real GDP. Growth rate of real GDP = Real GDP _ Real GDP in current year in previous year × 100 Real GDP in previous year 4

Example: If real GDP in the current year is $ 8.4 trillion If real GDP in the previous year was $ 8.0 trillion Growth rate of real GDP = $ 8.4 trillion - $ 8.0 trillion x 100 = 5 percent $ 8.0 trillion If real GDP in the current year is $ 8.4 trillion If real GDP in the previous year was $ 8.0 trillion Growth rate of real GDP = $ 8.4 trillion - $ 8.0 trillion x 100 = 5 percent $ 8.0 trillion 5

Growth Rate: The growth rate of real tells us how rapidly the total economy is expanding. This measure is useful for telling us about potential changes in the balance of economic power among nations. It does not tell us about changes in the standard of living. The growth rate of real tells us how rapidly the total economy is expanding. This measure is useful for telling us about potential changes in the balance of economic power among nations. It does not tell us about changes in the standard of living. 6

Standard of Living: The real GDP divided by population is known as ‘real GDP per person’. The standard of living depends on real GDP per person also called (per capita real GDP) The real GDP divided by population is known as ‘real GDP per person’. The standard of living depends on real GDP per person also called (per capita real GDP) 7

Example: If real GDP in the current year is $ 8.4 trillion, the population is 202 million. Then real GDP per person in the current year is $8.4 trillion divided by 202 million, which equals $41,584. If real GDP in the previous year was $ 8.0 trillion, the population was 200 million. Then real GDP per person in that was $8.0 trillion divided by 200 million, which equals $40,000. Growth rate of real GDP per person = $ 41,584 - $ 40,000 x 100 = 4 percent $ 40,000 If real GDP in the current year is $ 8.4 trillion, the population is 202 million. Then real GDP per person in the current year is $8.4 trillion divided by 202 million, which equals $41,584. If real GDP in the previous year was $ 8.0 trillion, the population was 200 million. Then real GDP per person in that was $8.0 trillion divided by 200 million, which equals $40,000. Growth rate of real GDP per person = $ 41,584 - $ 40,000 x 100 = 4 percent $ 40,000 8

Another Formula 9 Growth Rate of Real GDP per person Growth Rate of Real GDP Growth Rate of Populations

Example: Refer the above example Growth rate of population = 202 million million x 100 = 1 percent 200 million Growth rate of real GDP per person = 5 percent - 1 percent = 4 percent This formula makes it clear that real GDP per person grows only if real GDP grows faster than the population grows. If the growth rate of the population exceeds the growth of real GDP, then real person falls. 10

9.2 The sources of Economic Growth Real GDP grows: when quantities of the factors of production grow Or When persistent advances in technology make them increasingly productive. Real GDP grows: when quantities of the factors of production grow Or When persistent advances in technology make them increasingly productive. 11

9.2 The sources of Economic Growth We shall note that how saving and investment determine the growth rate of physical capital and how the growth of physical capital and human capital and advances in technology interact to determine the economic growth rate. 12

GDP growth effect: Real GDP growth contributes to improvements in our standard of living. Our standard of living improves only if we produce more goods and services with each hour of labor. Real GDP growth contributes to improvements in our standard of living. Our standard of living improves only if we produce more goods and services with each hour of labor. 13

Our main concern is to understand the forces that make our labor more productive We begin by the influences on real GDP that increase : Quantity of labor Labor productivity We begin by the influences on real GDP that increase : Quantity of labor Labor productivity 14

Quantity of labor The Quantity of labor is total number of labor hours available. The Quantity of labor = labor force x average hours per worker. The labor force depends on the population and the labor force participation. The Quantity of labor is total number of labor hours available. The Quantity of labor = labor force x average hours per worker. The labor force depends on the population and the labor force participation. 15

Population growth Population growth brings economic growth, but it does not bring growth in real GDP per person unless labor becomes more productive. 16

Labor productivity Labor productivity: The quantity of real GDP produced by one hour of labor. Labor productivity = Real GDP Aggregate hours Example: If real GDP is $8,000 billion and if aggregate hours are 200 billion, then Labor Productivity = $8,000 billions= $40 per 200 billion hours hour Labor productivity: The quantity of real GDP produced by one hour of labor. Labor productivity = Real GDP Aggregate hours Example: If real GDP is $8,000 billion and if aggregate hours are 200 billion, then Labor Productivity = $8,000 billions= $40 per 200 billion hours hour 17

Labor productivity If, Labor productivity = Real GDP Aggregate hours Therefore, if we turn the above formula, we can write it as, Real GDP = Aggregate hours x Labor productivity when labor productivity grows, real GDP per person grows. If, Labor productivity = Real GDP Aggregate hours Therefore, if we turn the above formula, we can write it as, Real GDP = Aggregate hours x Labor productivity when labor productivity grows, real GDP per person grows. 18

The growth of labor productivity The growth of labor productivity depends on three things: 1.Saving and investment in physical capital. 2.Expansion of human capital 3.Discovery of new technology. The growth of labor productivity depends on three things: 1.Saving and investment in physical capital. 2.Expansion of human capital 3.Discovery of new technology. 19

Saving and investment in Physical Capital: Saving and investment in physical capital increase the amount of capital per worker and increase labor productivity. 20

Expansion of Human Capital Human capital: the accumulated skill and knowledge of people – comes from two sources: 1.Education and Training Our ability to read, write and communicate effectively contributes enormously to our production. 2.Job experience School is not the only place where people acquire human capital. We also learn from on-the-job experience (i.e. learning by doing) 21

Discovery of new technology: The growth of physical capital and the expansion of human capital have made large contributions to economic growth, but the discovery and application of new technologies have an even greater contribution. 22

Discovery of new technology: The development of writing: imagine how difficult it would be to do any kind of business without any written records of accounts, invoices and agreements. Industrial Revolution: the development of mathematics led to the extension of physics, chemistry and biology led to Industrial Revolution. 23

The sources of economic growth 24 Population growth Labor force participation Average hours per worker Population growth Labor force participation Average hours per worker Physical capital growth Human capital growth Education and training Job experience Technological advances Physical capital growth Human capital growth Education and training Job experience Technological advances Quantity of labor growth Labor productivit y growth Real GDP growth