HOW DO YOU KNOW AN ECONOMY IS GROWING? Turn and Talk

Growth & Productivity LR Supply Side Policy Unit 7, Chapter 17

How to grow…SHORT RUN Increase use of existing capacity Rightward shift of AD curve (movement up the AS) A B THE SHORT RUN: increased capacity utilization

WHAT WOULD THAT INCREASE IN AD LOOK LIKE ON THE PHILLIPS CURVE? Reminder/Review

Economic Growth Increase in output (rGDP) Expansion of production possibilities Growth Rate= (rGDP2-rGDP1)/rGDP1

How to grow…LONG RUN Expansion of production possibilities Rightward shift of AS curve B A C THE LONG RUN: expanded capacity

Real Output (dollars per year) Price Level (average price) Shifts in Long-Run Supply AD 2 LRAS 2 AD 1 LRAS 1 AS E1E1 E2E2 E3E3 LO1

WHAT WOULD AN INCREASE IN AS LOOK LIKE ON THE PHILLIPS CURVE? Remember/Review Short RunLong Run

The Exponential Process The growth of the economy is an exponential process. Small economic growth compounds from year to year. RULE OF 72: How many years it takes for something (i.e. GDP) to double 72/the growth rate of GDP Every 1 percent of growth=an extra $500 GDP per capita

GDP per Capita: A Measure of Living Standards Growth in GDP per capita is attained only when the growth of output exceeds population growth. – GDP per capita – Total GDP divided by total population: average GDP.

GDP per Worker: A Measure of Productivity Increases in GDP per capita can also come from increases in output per worker. Productivity is measured as output per unit of input, e.g., output per labor-hour.

Source of Growth Future growth depends on two factors: – Growth rate of the labor force. – Growth rate of productivity. Growth rate of productivity Growth rate of labor force Growth rate of total output   LO1

HOW TO GROW… What would you do to boost economic growth?

Human-Capital Investment Education and skills training have greatly increased the quality of U.S. labor. The gains in productivity reflect greater human capital investment. – Human capital is the knowledge and skills possessed by the labor force. LO1

Physical-Capital Investment A primary determinant of labor productivity is the rate of capital investment. LO1

Comparative Investment and Growth LO1

Saving and Investment Rates Savings are not just a form of leakage, but a basic source of investment financing. There must be enough saving to at least finance net investment. – Net investment is gross investment less depreciation. LO1

Household and Business Saving Household saving rates in the U.S. are notoriously low. Virtually all U.S. investment has been financed with business saving and foreign investment. LO1

Management Training Investments in managerial talent are another source of economic growth. U.S. corporations spend billions of dollars on management training. LO1

Research and Development Research and development includes scientific research, product development, innovations in production techniques, and management improvements. LO1

New Growth Theory Old growth theory emphasized the importance of saving and investing in new plant and equipment. New growth theory emphasizes the importance of investing in knowledge and ideas. LO1

Policy Levers Growth policy makes liberal use of the tools in the supply-side tool box. – Increase human capital investment. – Increase physical-capital investment. – Maintain stable expectations. – Pro-growth institutional framework. LO2

Increasing Human Capital Investment Governments invest in human-capital by building, operating, and subsidizing schools. Immigration laws that promote immigration of skilled workers increase a nation’s stock of human capital. LO2

Increasing Physical Capital Investment As in the case of human capital, the possibilities for increasing physical-capital investment are also many and diverse. LO2

Investment Incentives The tax code offers mechanisms for stimulating investment: – Faster depreciation schedules. – Tax credits for new investments. – Lower business tax rates. LO2

Savings Incentives The government can use the tax code to deepen the savings pool that finances investment. LO2

Infrastructure Development The government also directly affects the level of physical capital through its public works spending. LO2

Fiscal Responsibility Short-run government policies may lead to a crowding out of consumer saving and investment. – Crowding out – A reduction in private-sector borrowing (and spending) caused by increased government borrowing. LO2

Fiscal Responsibility Fiscal and monetary policies must be evaluated in terms of their impact not only on (short-run) aggregate demand but also on long-run aggregate supply. LO2

A Pro-Growth Framework: Maintaining Stable Expectations Expectations are a critical factor in both consumption and investment behavior. A sense of political and economic stability is critical to any long-run current trends. – Smooth power transitions – Consistent rule of law LO2

AMONG THE TOOLS-- WHICH MIGHT BEST PROMOTE GROWTH? Processing & Evaluation

Next Steps Current Events Unit 7 Study Guide (due Monday)